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In this analysis, we take a look at where the Lloyd’s share price may be in five years’ time. We look at how Lloyds has performed historically in times of high interest rates, how they are profitable in a challenging market and whether Lloyds shares should be included in your long-term portfolio.

How did Lloyds Banking Group perform in the era of rising rates?

Lloyds Banking Group (LLOY) is one of the oldest banking institutions in the UK. Having merged with the Bank of Scotland, itself founded in 1695, during the Global Financial Crisis, the £28 billion Lloyds Group now owns a portfolio of market leading financial brands, including Halifax (demutualised building society), Scottish Widows and the high street-based Lloyds Bank.

Lloyds did survive the dark days of 2008. But its survival was conditioned on massive public loan guarantees and equity injection. It was only in 2017 that Lloyds was free from public ownership. In comparison, as of 2023 UK Treasury still owns 38.69% of Natwest (NWG).

Following the crisis, Lloyds’ balance sheet was strengthened; capital buffers increased. Prudence was the order of the day.

In the first six months of 2023, Lloyds reported a healthy set of results. Net interest income rose 14% yoy to £7 billion; while pre-tax profits gained 10% to £4.04 billion. More importantly, net interest margin edged by by 41bps to 3.18% (see below).

Net interest margin is the spread between the deposit rate it pays and the loan rate it charges. As banks are one of the most rate sensitive industries, the larger the margin the better.

The Group,” assessed Lloyds’ CEO Charlie Nunn, “delivered a robust financial performance in the first half of 2023 with strong net income and capital generation alongside resilient asset quality.” 

Profits against the odds

I agree with this assessment. The increasingly tumultuous economic currents –  the war in Ukraine, cost-of-living crisis and the highest borrowing costs in a generation – are all taking a toll on consumer confidence. But Lloyds is sailing through the rough conditions with increased profits. This is by no means an easy feat.

Why then, is the market not impressed? Lloyds’ share price dived 10% in the days after the earnings report in July. The answer, I suspect, lies in the market outlook.

Source: Lloyds Banking Group

Should you buy Lloyds’ shares for the next 5 years?

Lloyds shares these days are traded in the vicinity of 45p.

Prices peaked this year near 55p; following that high, Lloyds share went on a six-month slump (see below). The downtrend only paused at the major support level at 40p.

Why is the market so unimpressed by Lloyds results?

  • Shaky housing market – derived from high interest rates. This may cause Lloyds mortgage book to deteriorate.
  • Weaker consumer spending – due to high inflation rate. A curtailment in spending could hit Lloyds profits.
  • Contracting valuation – of the London equity market

Hence Lloyds is only valued at 6.1 (against last year’s earnings of 7.3p). A modest increase in this year’s earning will only bring the this price-earnings ratio lower.

To be fair, other UK banks are also under depressed market valuation. For example, at 158p Barclays (BARC) is trading at only 5.1x against last year’s earnings (of 30.8p, results here). Mr Market is utterly negative on banks.

But given this depressed outlook, is this the time to buy? There is a case for buying UK banks:

  • UK rate upswing – could be approaching the latter phase. Once we have passed the peak, perhaps this will cause the underlying UK economy to move up a gear
  • UK Equity valuation – may swing up in the next few years based on lower interest and inflation rates

Of course, this bullish outlook is further conditioned on banks continuing to churn out healthy profits. At this point, there are no major reasons to be concerned about Lloyds’ balance sheets.

Moreover, at a yield of 5.6%, investors are paid to wait for better times. And if you think UK stocks only go down, take a look at Rolls Royce (RR.) or Marks & Spencer (MKS). Both were trading at depressed levels for months – until some unexpected earnings catalysts spiked their share prices. It can happen to UK banks too.

Lloyds in the long-term?

In all, should you have some Lloyds shares in your long-term portfolio? I think the answer is yes. The market is pricing in a fairly negative outlook. However look to scale in rather than buying all in a chunk.

Technical levels to watch for: 50p to the upside; 40p floor.

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