A multi-billion-pound reason to buy boring Lloyds shares!

Lloyds (LSE: LLOY) shares were the top choice FTSE 100 in the latter half of 2022. But going forward from here, I’m still bullish on this UK-focused bank.

So let’s take a closer look at why.

Tailwind rates

Interest rates have risen, and there is reason to expect the Bank of England to increase rates further in the coming months. So far, interest rate hikes have been largely positive for banks, despite their downsides.

In its full-year results, published in February, Lloyds said net income had risen 14% to £18bn, with higher interest income due in 2022.

The net interest margin – the difference between lending and savings rates – rose 40 basis points to 2.94% in 2022. For 2023, Lloyds is targeting more than 3.05% as savings rates rise more slowly than lending rates.

It is also important to highlight that Lloyds also earns more from central bank deposits. Analysts suggest that Lloyds could attract around £3bn a year with additional income from £145.9bn of eligible assets and £78.3bn held as central bank reserves.

The higher the longer

Higher interest rates are good for banks, until they aren’t. The short-term forecast is for further increases. This is because inflation is more sticky than anticipated. There is also increasing pressure on wages which could lead to a spiraling downward spiral of wage prices.

In addition, it is worth noting that the UK economy may be considered too weak to absorb large rate increases. Many analysts see the base rate staying at 5%, but slowly falling to 3% or 2.5% over the next five years.

In general, I see this as quite positive. The current base rate is 4% and, in the short term, further increases may not make sense as customers may struggle to repay their loans. And while interest income may increase, it may also reduce the demand for debt.

However, the medium-term forecast looks more positive. The base rate is around 2-3.5% higher than the average for the last decade. And in good economic conditions, Lloyds can see net interest income remain high, while the cost of impairment falls.

This could be optimal for Lloyds, sending billions in extra revenue with bad debts falling. By 2022, impairment charges for potential bad debts will rise to £1.5bn.

Reasons to buy

First, as noted, the forecast above should be positive for the banks, and I expect to see Lloyds become more profitable within a decade. And with the bank trading at a price-to-earnings ratio of just 7.1, it looks like it’s worth it. It is half the index average.

The dividend also sits at an attractive 4.6%, but with a confirmed increase from 2p to 2.4p per share, the yield is further advanced. City analysts have forecast 2.7p for 2023 and 3p for 2024. With a current dividend coverage ratio of around three, there is certainly room for sustainable dividend growth.

I understand that some investors do not like to focus on the UK. All of these sales are in the UK and make it vulnerable to the downward trend in the UK economy. But this doesn’t bother me. In fact, I actually believe that English is more pragmatic.

I have often increased my position in Lloyds, and will buy more.