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Are Lloyds shares a FTSE 100 double-edged sword?


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Lloyds’ share price stands to benefit from record house prices and rising interest rates but remains exposed to the coming recession.

 

lloyds
Source: Bloomberg
Charles Archer | IG Financial Writer, London | Publication date: Friday 24 June 2022


Lloyds (LON: LLOY) shares started 2020 at 63p, before collapsing to 25p by September 2020 as the covid-19 pandemic raged. Recovering to 55p by mid-January this year, the FTSE 100 bank’s shares have now fallen to 43p, driven by the wider market rout.

Like many FTSE 100 companies, Lloyds has issued a one-time cost-of-living payment to staff, worth £1,000. And it’s delivered strong financial results recently; Q1 2022 saw a post-tax profit of £1.2 billion against £420 million in Q4 2021, while net income grew by 12% year-over-year to £4.1 billion.

Moreover, Lloyds has an attractive price-to-equity ratio of just 5.7, which compares very favourably to FTSE 100 competitors, including HSBC's 11.4 and NatWest's 8.8.

And it also boasts a solid 4.7% dividend yield, above the FTSE 100 average.

Lloyds shares: UK house prices
Lloyds currently has £451.8 million of loans and advances on its books, the lion’s share of which is its £295 billion open mortgage book. This market-leading position could prove advantageous in the coming months.

ONS April statistics show the average house price in England has risen by 11.9% over the past year to £299,249. Moreover, data from FTSE 100 property portal Rightmove show that average asking prices rose to a record £368,614 in June.

In addition, the Bank of England has increased the base interest rate five times since December to 1.25%, in an attempt to contain CPI inflation which is predicted to hit 11% by October. Further increases appear inevitable given the increased hawkishness of certain MPC members and the comparative steps taken by the US Federal Reserve.

Rising rates are already impacting on the 1.9 million borrowers on variable or tracker mortgages to the tune of hundreds of pounds a year. And while 75% of UK mortgage borrowers are on fixed rates, it’s only a matter of time before these deals expire.

If the economy holds up, this tightening fiscal policy could generate millions of extra pounds of profit for Lloyds over the next few years, after more than a decade of ultra-low rates.

lloyds 2Source: Bloomberg
 

FTSE 100 bank: recession fears
Of course, record house prices twinned with rising interest rates could be a double-edged sword.

Already, Rightmove thinks ‘the housing affordability crunch will have a greater impact on market behaviour in the months ahead…there are likely to be some month-on-month price falls during the second half of the year.’

Halifax managing director Russell Galley concurs that ‘the house price to income ratio is already at its highest ever level, and with interest rates on the rise and inflation further squeezing household budgets, it remains likely that the rate of house price growth will slow.’

In April, Lloyds CEO Charlie Nunn warned that ‘the outlook for the UK economy remains uncertain, particularly with regards to the persistency and impact of higher inflation.’ Moreover, he cautioned investors that Lloyds is ‘proactively contacting customers where we feel they may need assistance and will continue to help with financial health checks and other means of support.’

And worryingly, the situation has already worsened. Chris Williamson, chief business economist at S&P Global Market Intelligence, thinks ‘the economy is starting to look like it is running on empty’ with companies reporting a ‘near-stalling of demand.’ Outgoing CBI President Lord Bilimoria thinks the UK is ‘definitely’ heading for recession.

This leaves the FTSE 100’s largest mortgage lender with the risk that the cost-of-living squeeze will create a mass of home lending customers who face both negative equity and unaffordable re-mortgaging deals as their fixed rates expire.

Further, the government may not come to the rescue. In May, Capital Economics said that ‘the combination of a further weakening in economic activity and more interest rates rises will probably mean that borrowing overshoots the OBR’s 2022/23 forecast of £99bn by at least £10bn. That will limit the ability of the Chancellor to cut taxes and/or provide more grants to households.’

It's also worth noting that fears of a housing market slowdown are spreading across the Atlantic. Home sales fell by 2.4% in the US and 9% in Canada between April and May. JP Morgan, Wells Fargo, Compass, and Redfin are all laying off employees engaged in real estate.

BMO Capital Markets analyst Robert Kavcic thinks that the market expectations that caused many Canadian investors and households to stretch their finances in ‘fear of missing out,’ have begun ‘crumbling.’

And this equilibrium between increased profits supported by higher mortgage payments and a recession-induced housing market correction leaves the investment case for Lloyds shares on a knife-edge.

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