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The prospect of rising interest rates is usually a good thing for bank stocks. in fact, Lloyd’s Banking Group (LSE: LLOY)’s share price stability in 2022 owes much to rapid price increases.
But FTSE 100 Stocks fell on Monday on fears of sky-high interest rates. It was trading at around 44p per share, a three-week low.
Does this share price decline represent a buying opportunity? Lloyd’s shares certainly offer great value on paper. It trades at a price-to-earnings (P/E) ratio of 6.1 times and yields a dividend yield of 5.4%.
Why is Lloyds failing?
Lloyd’s shares are falling as investors worry about the impact of rising interest rates. This has the potential to drive bad loans as customers struggle to repay their debts. When consumer confidence dries up, they have the potential to reduce demand for credit.
Rising prices can cause the housing market to cool significantly. This is a particular risk for Lloyds mortgages because of their profitability. About 2/3 of all loans and advances to customers are mortgages.
Markets expect the Bank of England to raise rates by a full percentage point by the end of the week. As well as helping to support sterling, an increase in prices may be needed to reduce inflation.
Future price levels
| Lloyds share price | 44.3 p |
| 12 month price movement | -3% |
| Market roof | £31.5bn |
| Transfer price-to-earnings (P/E) ratio | 6.1 Time |
| Future profit rate | 5.4% |
| Split cover | 3 times |
The Bank of England has raised the benchmark for seven consecutive times since late last year. This also saw the bank’s net income rise by 12% between January and June (to £8.5bn).
High interest rates widen the gap between what banks charge borrowers and what they offer to savers. This will increase the income.
However, Lloyds’ sinking share price reflects fears that a rapid rate hike could now be a problem. Rates will rise to 3.25% this week, increasing expectations for a full percentage point rise from last week’s meeting.
Meanwhile, bets are mounting that interest rates will stay above 6 percent in the short to medium term.
High risk
On a positive note for Lloyds, I think mortgage lending will remain strong despite rising interest rates. Continued government support for first-time buyers – along with stamp duty cuts proposed in the Small Budget – should support the housing market.
But the view is not very certain, of course. And the bank can still face serious weakness elsewhere in my opinion. It made bad loan provision of £377m in the first half. And I think more serious charges may be coming.
Given the prospect of a long and severe UK recession and Lloyds’ overseas exposure, I’m happy to avoid buying the bank today.