2 lessons about Lloyds shares I learnt in 2022

I started the year having a position in a leading bank Lloyds (LSE: LLOY). Over the past year, the stock has turned around, but has generally been on a downward trend.

I ended the year with no Lloyds shares in my portfolio, although I continue to see the business as attractive.

Indeed, I would be happy to buy the company again in the future, depending on the prospects of the bank’s business and the share price. But now, the risk of defaulting on the loan that leads to profits is getting further and further away from them.

Here are two things I’ve learned about Lloyds shares this year.

Default risk is increasing

On paper, Lloyds looks like an attractive investment. It still has massive profits and trades at a price-to-earnings ratio of under eight.

It is one of the best-known names in financial services in the UK. It is also the largest mortgage lender in the country.

But despite everything, Lloyds looked cheap at the start of the year – and still looks cheap. Maybe investors are simultaneously making a big valuation mistake. But I think it’s more likely that there’s a risk that a recession could push more borrowers to take out loans, hurting profits at lenders like Lloyds.

What do we learn about this in 2022? In October, the company said that “asset flows into arrears, defaults and write-offs (ie) at low levels and below pre-pandemic levels“. That sounds optimistic. But the trend seems to be getting worse. Lloyds notes that the observed credit performance has shown evidence of deterioration, although there are “very humble“level so far.

The company also notes when it comes to impairment charges for the most recent quarter that it uses an updated outlook. This”including higher risks from an inflationary environment and higher interest rates“.

In other words, the bank sees a growing risk to profits compared to the picture at the beginning of the year. Going back, I expect default risk to grow, potentially keeping Lloyds shares down. But without a crystal ball, I’m not sure it would have happened. Twelve months have provided further evidence of what a worsening economy means for the banking sector.

Dividend restoration is slow

I understand that a company can have a healthy profit and cash flow but decide not to pay out to shareholders. But I am still very surprised this year by the unwillingness of Lloyds management to return the dividend to at least where it was before the pandemic.

In 2018, Lloyds made a post-tax profit of £4.5bn and paid a dividend per share of 3.21p. This year, it made a post-tax profit of £4.1 billion in the first nine months. However, despite the 19% interim dividend growth, it remains about a quarter below pre-pandemic levels. Now I expect the full-year picture to be similar.

It is not because of lack of cash. The company is spending £2bn this year to buy back its own shares. This could increase long-term shareholder value if Lloyds’ current share price is lower than expected. But it shows that management is not prioritizing bringing the dividend back to where it was before the pandemic.

This is one of the reasons I decided to sell Lloyds shares this year.