As a bank, Lloyds (LSE: LLOY) is fully exposed to the highs and lows of the economic cycle. When times are good, that can be massively lucrative. But with a recession likely heading our way soon, the bank could suffer from increased loan defaults. Arguably that risk is already priced into Lloyds shares, which are flat compared to where they stood a year ago.
So, would now be a good time for me to buy Lloyds shares for my portfolio – or ought I wait until after any recession?
The current investment case
In fact, I have already made a decision on that question and sold my Lloyds shares over the summer.
That reflected my concerns about the gathering economic clouds. But looking at things from another perspective, I do see a case for buying Lloyds shares right now. They look priced for hard times, having lost 30% of their value over the past five years. However, the UK banking sector has been notable for its resilience recently.
Lloyds’ price-to-earnings ratio of just seven looks cheap. The bank’s post-tax profit fell 27% in the first half compared to the same period last year – but still came in at a thumping £2.8bn. It also has the makings of a successful long-term business beyond the recession. Lloyds is the biggest mortgage lender in the UK. Its domestic focus means it will not be distracted by the sorts of international operations seen at rivals like HSBC and Barclays.
On top of that, a recession could cut both ways for banks. Loan defaults may increase (although at the interim stage, Lloyds noted that, “the flow of assets into arrears, defaults and write-offs remains at low levels”). However, rising interest rates also offer a profit opportunity. With higher rates, it is easier for banks to widen the gap between the rate at which they borrow and lend – a potential source of profits.
Given that Lloyds shares already seem to price in at least some of these risks, buying them now and buckling in for the long term could potentially turn out to be a lucrative investment strategy for me.
Waiting to buy Lloyds shares
However, why would I buy now instead of waiting to see what a recession does to the bank?
The uncertainty about Lloyds’ business prospects makes me think I might be better waiting to see exactly what a recession does to Lloyds. I could always buy the shares once the dust has settled if I think they offer attractive value at that point.
After the last financial crisis, Lloyds shares never recovered to their former level. If I had bought Lloyds at close to £3 per share back in 2007, I would still be nursing heavy losses today. The dividend also was cut — and did not return for many years. Today it remains far below where it stood before that financial crisis.
Lloyds is a different beast now, with a larger liquidity cushion thanks to bank rules being tightened after the last crisis. But a recession is often bad news for banks in general. That is why I am waiting to see what happens to the economy before deciding whether to add Lloyds shares back into my portfolio.