Looking ahead, the outlook for British banks appears bullish, with pent-up demand expected to be unleashed. When a strong economic recovery finally comes, it should favour cyclical businesses most. These companies’ earnings have the greatest potential to rise with surging consumer spending. Banks’ highly cyclical earnings are very much tied to the economic cycle, so they could benefit greatly from the widely anticipated rebound. Hence, here’s why I think the Lloyds (LSE: LLOY) share price might be a winner in 2021/22.
The Lloyds share price is up 20% in 2021
The Lloyds share price has come a long way since 22 September 2020, when it crashed to a 52-week low of 23.59p. What’s more, Lloyds shares have already got off to a great start in 2021. On Tuesday afternoon, they hovered around 43.76p, up 7.32p — a fifth (20%) — this calendar year. That’s ahead of the 6.6% rise in the FTSE 100 index since 2020. Nice.
Higher consumer and business lending?
During 2020, loan growth fell off a cliff as consumer lending shrank and individuals rushed to repay their debts. Now, British banks are optimistic that, as consumer spending builds, so too will demand for credit. With Lloyds being one of the UK’s biggest lenders to consumers and corporates, higher loan growth should translate into increased earnings. What’s more, any sustained boom could mean higher inflation and, in time, potential rate rises from the Bank of England. Higher interest rates should boost Lloyds’ revenue by reversing its declining net interest margin (NIM). The NIM is the spread Lloyds makes between savings and borrowing rates and it’s been falling for years. Both of these factors ought to support the Lloyds share price.
Releasing loan-loss reserves
During 2020, UK banks put aside tens of billions in extra reserves to cover bad debts and loan losses. However, thanks to huge government support for the economy, a large proportion of these expected losses has failed to materialise. As a result, Lloyds might be able to release some of the £4.2bn it set aside for loan losses in 2020. This rebate could allow the bank to increase its cash dividend or buy back its shares (all subject to regulatory approval, of course). Again, this could help the share price.
Our savings surge doesn’t help the Lloyds share price
One fly in the ointment is that Britons are saving like crazy. In the 30 years to 2019, the UK savings ratio — the proportion of disposable income we save — averaged 9%. A year ago, it surged to 25% and was 15.6% at end-2020. This savings glut will add £180bn to UK household savings in the five quarters to June 2021. But this wave of deposits isn’t good news for banks — not unless they can lend it out profitably. Hence, our newfound love for saving could actually act as a drag on the Lloyds share price. Oops.
In summary, the best news to boost the Lloyds share price would be a multi-year economic boom. And the worst thing for everyone would be if deadlier, more infectious new variants of Covid-19 take hold. Right now, the green shoots of growth are just emerging, but we should see more of them as the summer goes on. If all goes well, then the shares might finally rise above the 65p they hit in December 2019! On the balance of probabilities, I would definitely be a buyer of Lloyds at the current share price.