Could the cheap Lloyds share price be about to explode?

At Lloyds Banking Group (LSE:LLOY) share price rises 11% in 2023. But on paper, this FTSE 100 show banking still offers exceptional value.

City analysts estimate the company’s earnings will grow by 6% annually through 2023. That would make Lloyds shares trade at a price-to-earnings (P/E) ratio of just 6.8 times.

This kind of rating leaves scope for a new share price if the one-year results are impressive tomorrow (Tuesday, February 22). The retracement from the new one-year high also gives room for another move higher.

But I’m not ready to buy Lloyds shares for my own investment portfolio. Here I will explain why.

Reduced interest rate support

Rapidly rising interest rates have boosted bank profits for more than a year now. This month, the Bank of England (BoE) raised its benchmark for the tenth month in a row to 4%.

Higher rates are good for the likes of Lloyds. They raise the difference between what interest rates banks offer savings compared to what they charge for loans. In the first nine months of 2022, the rate hike pushed Lloyds’ net interest margin (NIM) to 2.84% from 2.52% in the same period a year earlier.

The Bank of England has tipped to keep raising rates in the first half of 2023. And Lloyds has predicted a NIM above 2.9% this year.

But I believe the bank may face a struggle to achieve this NIM target. Policy makers at the BoE (like Huw Pill, the deputy governor) have downplayed the dangers of hiking too far, casting doubt on the scale of future increases. There could be sharp cuts in 2023 to help Britain’s ailing economy.

On top of this, the intensification of competition from digital banks and challengers could also hamper Lloyds’ NIM ambitions. Lower overhead means online-led banks often offer more attractive products than established banks.

Consequently, high street operators must reduce interest costs and provide better savings rates to stop profits from stalling.

Another shocking flaw to come?

The recent rise in bad loans is another big danger for Lloyds this year. The number of credit impairments rose sharply to £668 million in the third quarter, the result of which pre-tax profit fell by 26% to £1.51 billion.

Third quarter total loans more than half bad loans of £1.05bn recorded by banks in the nine months to September. And I’m afraid that the one-year numbers released tomorrow will reveal other debt provisions that are worse than expected.

All banks in the UK are under threat of increasing impairments as the economy splutters. But Lloyds is perhaps more exposed than most due to its extremely high exposure to the buckling mortgage market. The Financial Conduct Authority predicts that 770,000 households are at risk of defaulting on their mortgage over the next two years.

Verdict

It is possible that Lloyds’ upcoming financial update will impress the market and push the share price higher. But that doesn’t change my view of the company as an investor. In my opinion, it is far too much risk to be considered wise to buy today.