Like all banks, this FTSE 100 stalwart is facing headwinds, but there is also one major tailwind. So let’s take a closer look at Lloyds’ fortunes and see whether this blue-chip stock is right for my portfolio.

Headwinds

Let’s start with the headwinds. In late October, the bank said pre-tax profit for Q3 fell 26% to £1.5bn. Impairment charges soared to £668m from a release of £119m a year ago. This large debt provision is hopefully not going to be entirely necessary, but it does speak volumes about the perceived health of the UK economy.

There are recessionary forecasts for the UK economy, as with much of Europe. And recessions aren’t good for credit quality. However, it’s worth noting the UK economy has surprised us before. Plus falling gas and fuel prices could play an important role in slowing inflation.

Tailwinds

Interest rates have been increasing throughout 2022. It’s likely that the Bank of England will continue increasing the base rate through to 2023. In fact, some analysts see the base rate hitting 4% in 2023.

As such, net interest margins (NIMs) — the difference between savings and lending rates — are rising considerably. In its Q3 update, Lloyds said it expects its NIM to be above 2.9%, up from 2.8%. Lloyds is even earning more interest on the money it leaves with the central bank.

Lloyds trades at a fraction of its pre-2008 crash price. There are several reasons for this, but a major one is more than a decade of near-zero interest rates. Now, with rates increasing to levels not seen since the noughties, income is soaring. Despite the impairment charges, net income in Q3 rose 12% to £13bn on the back of surging interest rates.

This is clearly positive. It provides the bank with the ability to absorb sizeable impairment charges in the short term. But, in the long run, it should provide Lloyds with more capital to invest in new projects. For example, Lloyds is planning to enter the UK rental market by buying as many as 50,000 homes over the next decade. It’s definitely a project that interests me.

Why I’m buying more Lloyds stock

I already own Lloyds shares but, at 42p, I see now as a good time for me to buy more. Despite the immediate headwinds, I’m confident higher interest rates will translate into greater returns for shareholders in the medium-to-long term.

It’s certainly not expensive either, with a price-to-earning ratio of 5.6 — that’s substantially under the index average. And despite dividend payments being depressed on a historical basis, the yield is currently a healthy 4.75%. That’s certainly attractive and, with coverage at 3.75 last year, sustainable.

This month, I’m considering three FTSE 100 stocks that I think could be great long-term investments.

The UK’s most popular dividend stock?

Lloyds Banking Group (LSE: LLOY) is firing on all cylinders. The bank says its revenue rose 13% to £4.6bn during the third quarter, mainly due to higher interest income.

Rising interest rates could provide a big boost to bank profits, but they also bring a couple of new risks. If bank profits soar while many people are struggling to pay their bills, the government might introduce a windfall tax.

The second risk is that rising rates could trigger a sharp rise in bad debt. Lloyds is the UK’s largest mortgage lender, so it’s exposed to the risk of rising arrears when homeowners are forced onto higher rates.

Lloyds says it hasn’t seen any sign of rising bad debts yet. However, the bank has already accounted for £1bn of expected future losses this year, in recognition of this risk.

A UK recession could hit Lloyds’ profits. But the bank’s balance sheet looks strong to me, and I think the 6% dividend yield looks very safe.

A family-owned business I’d buy

Food and fashion group Associated British Foods (LSE: ABF) owns brands including Primark, Twinings and Kingsmill. The last couple of years have been tough, especially for Primark, which doesn’t sell online.

Profits are still well below the peak levels seen in 2017/18. But ABF went into the pandemic with plenty of cash and minimal debt. This strong financial position has allowed the family-controlled group to orchestrate a strong, planned recovery.

Short-term risks remain. Primark is only just starting to experiment online, but rather from a click & collect perspective than selling direct. High commodity costs and supply chain problem could also continue to cause disruption.

However, I admire the long-term focus of this business, which is still run and controlled by the founding Weston family. ABF shares currently trade in line with their book value, on just 10 times forecast earnings. I reckon the stock looks good value at this level.

An overlooked FTSE 100 stock?

My final pick is FTSE 100 cement and aggregates group CRH (LSE: CRH). This business operates throughout Europe and North America. Its UK operations include building materials company Tarmac.

I’ve tended to overlook CRH over the years. But with the shares down 25% so far this year, I’m starting to think this business could be a good long-term buy.

CRH’s products are essential to many industries, while the company’s size is allowing it to invest in cutting carbon emissions and becoming more sustainable.

This FTSE 100 stock looks reasonably priced to me, with a price-to-earnings ratio of 10. But I think the main risk is that it’s still too early to buy. If the global economy continues to slow, CRH’s earnings (and share price) could fall.

What I’m doing

I’m currently waiting for some cash to arrive in my portfolio from a takeover bid for one of my existing stocks. Until then, I plan to continue researching these stocks.

I think they all have the potential to be good long-term investments at today’s prices.

They’ve helped widen the profits the bank has made on its lending activities. More support from the Bank of England’s rate setting committee can be expected, too.

But this doesn’t mean I’d buy the FTSE 100 bank today. Here are just three reasons I’m avoiding Lloyds shares today.

1. A collapsing housing market

Lloyds is a major player in the UK mortgages market. Unfortunately for the bank, this sector is critical in driving the bottom line.

Data today from Nationwide showed home sales fall for the first time in 15 months in November. Demand from homebuyers fell because of soaring interest rates to tame inflation and support the flagging pound.

They’ve risen by half a percentage point at the last two Bank of England meetings. And an even-bigger 0.75% hike is predicted at the latest meeting this Thursday. No wonder Lloyds is tipping home sales to fall 8% in 2023.

2. Broad-based weakness

Surging interest rates threaten to crush demand for mortgage products in the short-to-medium term. There’s also a danger of missed home loan payments increasing to eye-popping levels.

This partly explains why Lloyds set aside another £668m for bad loans provisions in the third quarter. It caused the bank to miss City profit forecasts. And more are likely to be coming down the pipe as the UK economy toils.

The problem for Lloyds, however, is that it faces weak revenues growth and a surge in loan impairments across the board. Indeed, total loans and advances clocked in at £456.3bn in the third quarter, basically flat from the prior three months.

That’s the trouble with investing in highly cyclical shares like banks. Profits can soar when the economy is thriving. They usually sink when times get tough.

3. Lack of overseas exposure

But Lloyds offers an extra layer of risk to investors. Its focus on the British retail banking sector means it doesn’t benefit from geographic diversification.

Unlike Barclays, HSBC, and Standard Chartered, for instance, it can’t look to other markets to drive earnings during tough periods at home. This is particularly troublesome today as Britain’s economy is expected to perform particularly badly over the short-to-medium term.

The IMF, for example, has forecast UK growth of just 0.2% in 2023. This is well below the 2.7% that the broader global economy is tipped to grow at.

Cheap for a reason

It’s true that Lloyds’ shares look enormously cheap on paper. It trades on a forward price-to-earnings (P/E) ratio of below 10 times. Its dividend yield meanwhile smashes the FTSE 100 average of 4%.

But I don’t consider Lloyds’ share price as a bargain. Brokers now expect earnings to drop year on year in both 2022 and 2023. And I think more forecast downgrades could be in store. This is a high-risk UK share I plan to avoid at all costs.

But there are signs of positive news for the banking industry as interest rates rise. So, should I start buying Lloyds shares again now for my portfolio while I can still bag them at the current price?

Some good news for banks

Higher interest rates can be bad for borrowers because they need to pay more when servicing their loans. But that can be good for banks as they stand on the other side of the transaction. As the UK’s largest mortgage lender, I think this could be a key benefit for Lloyds from interest rate hikes. That might help support an increased share price.

Indeed, in the bank’s third-quarter trading statement released last week, there was already evidence of this happening. Underlying net interest income for the first nine months came in at £9.5bn, a 15% increase over the same period last year. I expect interest income may remain elevated for the foreseeable future due to higher rates.

Bad news too

But already we also see some evidence of how higher interest rates, along with a worsening economy in general, could be bad for the bank’s financial performance.

Statutory profit before tax for the quarter fell 26%. It still came in at £4bn, which is a lot. Lloyds has a market capitalisation of £28bn, so its shares continue to trade on a low price-to-earnings ratio. That could make its current valuation look attractive. But the fall is a large one. Moreover I think we are only seeing the start of how higher interest rates might impact profits. Next year could be worse.

The financial services powerhouse also changed its outlook for the year, specifically citing interest rate changes as a risk when it referred to “the balance of risks shifting from Covid-19 to increased inflationary pressures and rising interest rates”.

That led to a gloomier outlook than Lloyds had before. For example, it increased its expected credit loss in the first nine months of 2022 from £4.5bn at the start of the year to £5bn now. Big interest rate rises have only kicked in fairly recently for many borrowers, so I think such news could get worse over the winter and into 2023.

I’m not tempted by the Lloyds share price

That is why, despite the Lloyds share price falling and a dividend yield now exceeding 5%, I will not be adding it to my investments any time soon.

I think it has real strengths, from its large customer base to a strong assortment of banking brands. If investors focus on those and the economy suddenly shows signs of recovery, the Lloyds share price could start to turn around.

I would be surprised to see that in November though. The UK economy is struggling and rising interest rates could mean higher default rates eating further into Lloyds’ profits.

That could be bad for the Lloyds share price in November and beyond. For now I see better opportunities for my portfolio elsewhere in the UK stock market.

So with an economic downturn/recession forecast in the UK and elsewhere in the world, could the Lloyds share price tank?

Bad debt and other headwinds

On Thursday, Lloyds said profits for the quarter had fallen on bad loan charges. Pre-tax profit fell 26% to £1.5bn. Net income rose 12% to £13bn on the back of surging interest rates with impairment charges soaring to £668m from a release of £119m a year ago.

Chief executive Charlie Nunn highlighted that the current environment was “challenging for many people.” However, Lloyds also said there had been only “very modest” evidence of customers struggling with repayments to date, with CFO William Chalmers noting that customers were “resilient and [were] adapting well to the cost-of-living increases that we have seen.”

Banks, including Lloyds, are also reeling from the impact of Liz Truss’s catastrophic financial policies which sent markets into turmoil. Following September’s mini-budget, and reactionary interest rate hike, many banks removed products from the market.

One big plus

Banks, including Lloyds, have already put money aside for inflation and recession-related defaults. But the big plus is net interest margins (NIMs) — the difference between savings and lending rates. These have been rising considerably as the Bank of England raised the base rate.

The bank now expects net interest margin to be above 2.9%, up from 2.8%. Chalmers said the bank will be passing about half of rising rates through to savings customers, in line with its competitors. It’s also worth noting that Lloyds is even earning more interest on the money it leaves with the central bank.

Will Lloyds shares tank?

The recession in the UK isn’t anticipated to be too deep, and that’s a positive for banks. Instead, I see bank profits remaining sizeable on the back of higher NIMs. Lloyds’ bad debt provision is considerable, but you’d expect banks to be preparing for the worst, and hoping for the best.

I actually see the Lloyds share price rising back towards 50p as NIMs push revenue higher. There’s also evidence that the macroeconomic environment is improving, especially now Truss is out of office. Natural gas prices, which is one of the core factors behind global inflation, are falling quickly. In fact, UK prices are down 72% since the summer peak. And this should make a huge difference to the state of the British economy.

I already own Lloyds shares but, at 43p, I’d buy more. There are headwinds right now, but the economic forecast is looking a lot better now than it did a month ago. The higher NIM forecast is also extremely positive. There’s also the matter of an attractive 4.7% dividend yield.

It’s been a tough year for the business. The grim economic outlook has seen its share price fall by 14% in 2022. Across the last 12 months, it’s down a slightly more respectable 12%.

However, with the stock currently trading for around 43p, I think now would be a good time to add it to my portfolio. Here’s why.

Lloyds profits slide

It hasn’t been the smoothest ride for long-term Lloyds shareholders. And yesterday this continued as the bank announced that its pre-tax profits for Q3 fell by over 25% to £1.5bn.

The fall was largely pinned to provisions for bad debts and loan losses. And with these jumping to £668m, this indicates that Lloyds is protecting itself against customers who may default on payments in the future.

The release saw the Lloyds share price slip in the early hours of the morning. That said, it recovered to finish yesterday slightly up.

Silver lining

The large drop in profits clearly isn’t what Lloyds shareholders wanted to hear. But it’s not all bad news. One major positive was the 13% rise in net income due to rising interest rates. With rates in the UK currently sat at 2.25%, this has allowed the firm to charge customers more when they borrow from the bank. With this, Lloyds was also able to increase its net interest margins.

As inflation continues to soar and show no signs of slowing down as we head into 2023, there have also been predictions that rates could be hiked to as high as 4% in the months and years ahead. Going forward, this will continue to provide a boost for Lloyds.

What I also like about Lloyds is the passive income stream I can create by buying the stock. With a FTSE 100 average-beating 5% dividend yield, the stock seems like a smart play in current times. Its low price-to-earnings ratio of seven is also an attractive factor.

Housing market slowdown

Lloyds also gave a bleak prediction for the future state of the UK housing market. And as of one the largest mortgage lenders, this may spell trouble for the business. It predicted that UK house prices will fall by 8% next year, followed by a long period of stagnation.

However, this could be offset by its new rental venture, Citra Living, and it has predicted that demand is set to increase across the next five years.

Why I’d buy

There’s no doubt in my mind that Lloyds shares will be a slow burner. However, as a Fool, a long-term approach to investing doesn’t faze me. The short term may be volatile for the business as the UK braces itself for a tough year ahead. However, with the bank set to benefit from rising interest rates, along with its substantial dividend yield, I think the stock is a smart buy. While I don’t have any spare cash right now, if I did, I’d happily buy Lloyds shares at their current price.

With centuries of experience, these banks have been crucial in developing the British economy as you know it today. They have funded businesses throughout the country and have helped elevate the economy. 

As a result, the top UK banking shares today offer strong dividends and steady growth. And over the years they have become the pillars of the investment community in the country.

We’ll break down what beginner investors need to know to explore and invest in the thriving UK finance sector, by looking at the top five banking shares in terms of market share. 

What are bank shares?

Bank shares are publicly listed companies that provide a broad range of financial services to the public and businesses alike. 

Common operations include maintaining accounts and providing loans, mortgages, and asset management services. Banking groups also provide secure transactional pathways that enable account holders to pay and receive money via instruments like credit cards, debit cards, and digital transfers.

Top UK banking shares

Here are some of the top UK banking shares in order of highest market cap.

1.  HSBC Holdings 

The European banking giant, established in Hong Kong in 1865, has grown to become a huge force in the field. Currently, HSBC Holdings (LSE:HSBA) has the highest total assets of all major European banks, worth over $15trn. And the banking firm now has a new area of focus and a new strategy that looks exciting on paper. 

In the midst of the pandemic in 2021, HSBC announced that it was switching focus to the growing Asian markets while slowly withdrawing from Britain and the US. This led to the banker cutting over 35,000 jobs and acquiring smaller banking groups in countries like Singapore and India, further cementing its Asia-first strategy. 

And the move as already proven to be a successful switch for the banker. In July 2022, HSBC announced that it had become the first foreign lender to open a Communist Party of China committee in its Chinese investment banking subsidiary. While this move has been criticised by regulators in the UK, investors see this as a strong move that could open up a vast, economically affluent market.

As of July 2022, HSBC shares have regularly outperformed the FTSE 100 index. While this is not an indicator of future returns, 2022 has been a very turbulent economic period. This banking share’s ability to navigate choppy waters is impressive.

2.  Banco Santander SA

Banco Santander (LSE:BNC) or Santander Bank as it is known in the UK, is the 16th largest multinational bank in the world. It is one of the biggest bankers listed in the LSE today and has a huge presence in South America. It is also expanding slowly into the emerging Asian market as well. 

Santander’s priority over the last few years has been customer acquisition. Its campaign has proven successful, adding 32m new customers since 2015 and taking its total customer base to 153m. During this growth, the business has been maintaining a steady operating income that hasn’t dipped below €20bn since 2008.

And profits have been increasing too. In fact, 2021 was the most profitable year for the bank in its history, bringing in €15.3bn, thanks to strong business momentum across most regions. The company is also seeing loan approval rates go up in cash-rich regions like Europe and the US. The repaying ability of the average citizen in those regions is much higher than in Santander’s developing markets, which is a sign that recurring revenue growth could be high over the coming years. 

Santander shares might be lagging behind some of the other companies on this list when it comes to digital banking services. But it is making good strides and is actively developing a range of digital banking services. In 2021, 54% of its total sales were through its digital channels.

3.  Lloyds Banking Group 

As a mainstay of the British finance sector, Lloyds Banking Group (LSE:LLOY) is the most recognised bank in the UK. Since its operations are highly focused around Britain, Lloyds shares and its performance are seen as a barometer for the larger UK economy.

The cash-rich banker is looking to diversify its assets. Since a large majority of its income is from mortgage lending, the banker decided to enter the real estate market in full force in 2021. A partnership with top UK real estate developer Barratt Developments will see the bank acquire 50,000 plots by 2030, making it a top 10 developer in the region. 

Diversifying assets is crucial for UK banking stocks to avoid the pitfalls of recessions. The only way banks can offset losses from payment defaults is to invest their excess cash effectively. And despite falling housing prices, this move may open up a whole new market for Lloyds to explore over the next decade. Offering prepackaged loans for houses developed by Lloyds could become a unique sales pitch that could draw young buyers.

4.  Barclays

This universal British banker offers banking and investment solutions across the globe. With a strong presence in the US as well as top economies in Europe, Barclays (LSE:BARC) is one of the most recognised names in the world of finance. 

The firm has made between £5bn and £8bn a year since 2018 on credit card payments alone. It also has a thriving business banking division and is a highly digitised business offering cutting-edge mobile banking solutions. Its banking app is one of the most downloaded in the western world with 10m users (as of 2021) and 3bn+ logins.

This FTSE 100 bank share’s poor performance across 2022, given the economic turbulence in the UK, has made its valuation incredibly attractive. It is currently one of the cheapest blue-chip banking stocks listed on the LSE. But investors and the board alike are sure that Barclays, like most top banking shares, will make a strong comeback as things get better.

5.  Natwest Group 

The final banking share on our list is no slouch. Natwest Group (LSE:NWG) is the largest business banker in the country. Supporting over 19m customers in the UK, Natwest aims to provide cutting-edge banking solutions and also has lofty environmental sustainability goals.

In fact, Natwest announced its Green Mortgage product, with £728m of lending allocated to champion green businesses. The bank supports several businesses that are helping other businesses meet their environmental goals as well. Natwest’s digital offerings are popular too. Over 60% of its retail current account holders interact with the bank only through digital mediums. 

On the business side, 2021 was a great year for Natwest. Total lending values grew by £7.8bn, primarily driven by mortgages. While this UK share has struggled like every other financial institution in 2022, over the last 12 months of trading, Natwest shares have risen over 15%. This places it second in terms of returns compared to all other banks on this list (behind HSBC). 

This shows investor confidence when the FTSE 100 index has been struggling for stability. And looking at Natwest’s historic dividend growth and the average yield of 4.5% across 2022, it is clear why investors favour this banking share over others.

Why are UK bank shares falling in 2022?

In 2022, markets worldwide have witnessed huge collapses. It is clear now that the economic impact of the pandemic will be drawn out. And the UK is in a particularly vulnerable state right now due to rising geopolitical tensions in Europe and the ever-changing energy lobby. 

Rising costs have raised inflation throughout the year and are expected to outstrip 11% by the end of 2022. As a result, banking shares have become a hot topic of debate right now as the Bank of England mulls further interest rate hikes. While some big lenders like Lloyds stand to benefit from higher interest payments in the short term, investors are still concerned about the spending power of the average citizen if the UK enters a recession. 

Forcing consumers to save every penny creates a bad business environment, especially for banks. Most banks make money for every transaction and thus stand to make less in a recession. Historically, a period of poor economic growth is marked by banking stocks falling fast. Also, in a recession, payment defaults could increase, which is a liability. 

Will banking shares recover?

The data shows that finance shares are the first ones to recover from a crash because banks tend to invest right, be cash-rich, and use governmental support to recover losses quickly. 

All the banking shares discussed on this list are considered blue-chip finance stocks with huge cash reserves and assets. And even in an economic downturn, banking services will be essential. Even after the crash in 2020, the banking stocks on this list have shown strong signs of recovery and are steadily posting better results every quarter.

If you are looking to add UK banking shares to your portfolio as a growth option or for passive income, these bankers are a great starting point. By understanding how these top banking shares are different, new investors can understand the fundamentals better and know what to expect from an investment in banking shares in the UK. 

The Lloyds share price drops again

As I write early on Thursday morning, the Lloyds share price hovers around 41.89p, down 0.66p (-1.6%) since Wednesday’s close. At its morning low, the Black Horse bank’s stock dipped to an intra-day low of 40.86p, before rebounding by more than penny. At this level, the bank is valued at £28.2bn — a fraction of its pre-2008 high.

The bad news for long-suffering Lloyds shareholders is that its quarterly pre-tax profit slumped by more than a quarter (-25.7%). In the quarter ending 30 September, the bank recorded a before-tax profit of £1.5bn, versus over £2bn in Q3/21. This was well below analysts’ average forecast of £1.8bn.

So what went wrong to slash the bank’s profits? The answer is provisions for bad debts and loan losses, which soared to £668m. In Q3/21, the bank actually released £119m of previous reserves, so this amounts to a negative swing of £787m. Ouch.

But it wasn’t all bad news

Despite this setback, there was also good news buried in Lloyds’ latest numbers. For example:

• Thanks to rising interest rates, the bank’s quarterly net income leapt 13% to almost £4.6bn.
• Lloyds’ net interest margin jumped from 2.55% in Q3/21 to 2.98% in Q3/22, up 43 basis points.
• The cost-to-income ratio dropped to 47.8% from 51.8%, improving by four percentage points.
• Various measures of the bank’s balance-sheet strength also strengthened.

Alas, with our economy facing hurricane-force headwinds, being the UK’s biggest retail bank is hardly ideal. The soaring cost of living, skyrocketing energy and fuel bills, rising mortgage rates and the growing risk of a prolonged recession are battering consumer confidence.

What next for Lloyds shares?

I don’t own a crystal ball, so I can’t make accurate predictions about the future direction of the Lloyds share price. But here’s how it’s performed over six timescales:

To be frank, Lloyds shares have been a long-term lemon, losing almost two-fifths of their value in the past half-decade. But I buy into businesses based on their future and not their past. And the group’s current fundamentals look promising to me.

At the current Lloyds share price of 41.89p, this FTSE 100 stock trades on a modest price-to-earnings ratio of 6.9. This translates into an earnings yield of 14.4%, which covers the running dividend yield of 5.1% by 2.8 times. To me, this cash yield looks secure — for now, at least.

To me, these numbers indicate that Lloyds shares are cheap today, relative to the wider market. But Lloyds has been a perennial value trap, sucking in fresh investors for years, before crushing their dreams. Even so, I have no intention of selling any of the Lloyds shares in my family portfolio. In fact, if this stock gets much cheaper, I may well buy more shares!

As a value investor, I’m attracted by many of the FTSE 100 bargains currently on offer. Stock market volatility this year has left plenty of good shares trading below value. Rio Tinto and Bunzl are a couple of beaten-down blue-chips I’ve recently bought.

All-round value

The question is whether Lloyds shares fall into this category. And I can’t deny that on paper ‘The ‘Black Horse Bank’ looks great value for money.

At 42.5p per share, Lloyds commands a forward price-to-earnings (P/E) ratio of 6 times. I’m also drawn to the company’s enormous 5.6% dividend yield.

So should I take a chance and buy the battered banking stock for my portfolio?

That P/E ratio

A low P/E ratio can be interpreted several ways. A reading of 10 times and below can suggest that a stock is undervalued. A rock-bottom earnings multiple can also be common among mature companies with low-but-stable growth prospects. Finally, a low P/E ratio can suggest the market expects a stock will fail to meet broker forecasts.

I view Lloyds’ low multiple as a red flag concerning future earnings. As the economic outlook darkens the bank’s profits potential is also reducing. In fact, City analysts have been steadily downgrading Lloyds’ medium-term forecasts in recent months. Today, the number crunchers think earnings will drop 4% in 2022 and 5% in 2023.

I think more downgrades could be coming for the FTSE 100 bank too. Recent forecast reductions reflect the increasingly gloomy picture for the domestic economy. And economists and analysts continue to reduce their GDP estimates (Goldman Sachs, for instance, predicted a 1% contraction in 2023).

Prolonged weakness

The threat of disappointing near-term earnings isn’t something that would necessarily deter me from investing in a stock. Indeed, Lloyds is a share I’d consider buying if its earnings prospects were compelling from a long-term perspective.

This is because I buy UK shares with a view to holding them for the long haul. The trouble for Lloyds, however, is its lack of exposure to foreign markets.

The bank can spend heavily on acquisitions to address this, but this is unlikely. So things look bleak profits-wise as Britain likely enters a period of economic upheaval. The decision of ratings agency Moody’s to cut the UK’s financial outlook to ‘negative’ is a sign of the potential trouble to come.

UK banks I’d rather buy

The one thing I like about Lloyds is its commanding share of the UK mortgage market. Over the long term, I believe this will remain a lucrative area for the bank, given the bright outlook for home prices.

However, this alone doesn’t make Lloyds shares an attractive buy in my book. In fact, I’d rather invest in other banking stocks such as HSBC or Santander instead.

These companies have significant exposure to fast-growing emerging markets. What’s more, they trade on ultra-low P/E ratios of 7 times and 5 times respectively. Unlike Lloyds, I think these are genuinely good bargains to buy right now.

But apart from a pandemic interruption, dividends have kept my investment above water. Only just, but it’s not the wipeout that the price chart might suggest.

Generating income

I eventually want to to take a stream of income from my shares. Until then, I intend to make further regular investments. And that reminds me of billionaire investor Warren Buffett’s analogy about eating burgers.

People who eat burgers will surely be happier if beef prices fall. But investors who plan to keep buying shares tend to cheer price rises instead. That doesn’t make sense. As a net buyer of Lloyds shares, a share price fall should put me in a better long-term position.

A lower price means I can buy more shares for the same money. And hopefully that will get me more long-term income than if the price rises.

Long-term target

How much could I aim for if I bought Lloyds shares at today’s price, and carried on for another 10 years? With the Lloyds share price depressed, we’re looking at a forecast dividend yield of 5% this year. And analysts see that rising to 6% by 2024. Forecasts are often wrong, but I think there’s a good chance of seeing an average of 6% over the next decade (based on today’s share price).

Suppose I invest just £100 per month in Lloyds shares, and keep doing that for the next 10 years. And I reinvest all my dividends in more Lloyds shares. In 10 years time, my shareholding would have grown to a little over £16,000. And if I stopped then, I’d be able to take £110 in income every month.

If I could invest as much as £500 per month, I could end up taking £550 per month in income. So to approximate, every monthly £100 I invest in Lloyds shares over a 10-year period could then generate about the same in income every month… for ever.

Reality

This is all based on a Lloyds share price of 41p at the time of writing. And on that price not changing, with the dividend yield remaining fixed at 6%.

Those are not realistic assumptions. I expect Lloyds shares will rise in price and the dividend yield will fall. If that happens, my monthly investments will get me fewer shares in future years, and I’ll get a lower percentage dividend return on them.

And that shows why Buffett’s burger thing is so true. The longer the Lloyds share price remains low, the better I should do in my pursuit of eventual income.

Caution

I’m not advocating buying Lloyds shares specifically, and I haven’t looked at the risks — of Lloyds, or of bank shares in general. And this is just an illustration of what these sample figures might produce.

But I think it does help show how buying dividend shares can generate long-term income. And how low share prices are the long-term investor’s friend.