It hasn’t been a great week for shareholders in Lloyds (LSE: LLOY). While it recovered somewhat today, the Lloyds share price was still almost 4% down in the past five days at the time of writing this article yesterday. But I am bullish on the prospects for the leading banking group.
Here are three reasons I think the Lloyds share price is attractive right now and would consider adding more to my portfolio.
1. Earnings are strong
Last week, the bank reported profits for the first three quarters of this year of £4.96bn. But its total market capitalisation at the moment is only around £35bn. In other words, if the fourth quarter comes in broadly in line with the year to date, the bank trades on a price-to-earnings ratio of around six. For a bank the size and quality of Lloyds, I think that looks cheap.
Nor do I see this as a one-off. The earnings reflect the strength of Lloyds’ business, especially its mortgage book, and how it operates. I don’t see that as about to change. Let’s imagine a scenario that could threaten earnings, such as a large downwards shift in the housing market. Not only do I think that is less likely given tight housing demand, I also reckon it might not be that bad for Lloyds’ earnings. Most borrowers would continue to pay their mortgages, experience has shown us.
In such a situation, the bank might need to make provisions for bad loans. That risks profits falling. But even when Lloyds initially made such provisions last year, it still recorded over £1bn of profits. Now that it is a landlord, repossessing property may also be less financially harmful for Lloyds’ results, as it can potentially rent out the homes concerned.
2. Dividend prospects look good
Lloyds currently yields 1.2%, which isn’t that exciting for me. But it is paying out at a lower rate than it did before the pandemic hit. The bank has already signalled that it plans to increase the dividend over time. I think that could be good for the Lloyds share price as well as for my passive income streams.
But what most attracts me about the dividend prospects here is that Lloyds has been stockpiling cash. In last week’s results, the bank revealed that its CET1 ratio at the end of September was 16%, up from 15.5% at the start of the year. That is basically an indicator of the company’s excess cash. It targets a CET1 ratio of 12.5% and a 1% buffer. So the bank is sitting on substantial amounts of capital that are surplus to requirements. That could fund bigger dividends.
3. Economic resilience
Concern about increased interest rates has dampened enthusiasm for Lloyds. I see increased interest rates as inevitable, the only question is when they will arrive. They could be bad news for a lender like Lloyds, hurting revenues. But I think they could actually be good news.
The ongoing sustained period of super low interest rates is an historical anomaly. Higher interest rates will give lenders more flexibility to compete on things like service and reputation rather than simply race to the bottom on interest rates. So I think a higher interest rate environment could actually play to Lloyds’ strengths as the UK’s biggest mortgage lender.