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The Lloyds Banking Group (LSE:LLOY) share price has been on an amazing run lately. Looking back six months, one year and five years, it’s risen 30%, 77% and 174%, respectively. As I write (12 November), I could buy a share for 95.1p. The next target is 100p. The last time the stock was trading above £1 was just before the 2008-09 global financial crisis.
A domestic focus
The rally has been even more remarkable given the economic backdrop. Nearly all of the bank’s revenue is earned domestically. This means it has an almost total reliance on a shaky British economy. One that’s struggling to grow with the national debt rising.
Impressively, it’s estimated that Lloyds has a 20% share of the UK mortgage market. But although there are some signs that the housing market is picking up following a series of interest rate cuts, a continued recovery is far from certain. The Chancellor’s expected to raise taxes in this month’s budget, which is likely to squeeze incomes and could depress demand for new mortgages.
However, if reports are to be believed, Rachel Reeves has ruled out imposing a windfall tax on Britain’s banks.
Lloyds also appears to have dodged a bullet when it comes to the alleged mis-selling of car finance. It’s believed that the bank accounts for around a fifth of the country’s car finance deals. The amount that it’s likely to pay in fines and compensation under the Financial Conduct Authority’s current proposal is much less than most observers previously thought.
‘Expert’ opinion
Conventional wisdom is that banks do better during periods of high interest rates. It gives them scope to increase the differential between the amount charged on loans and what it pays on customer deposits. Undoubtedly, Lloyds has benefitted from the post-pandemic rise in borrowing costs.
But with most economists expecting interest rates to fall over the next couple of years, this could adversely affect the bank’s bottom line. However, much to my surprise, the consensus of analysts is for its net interest margin to rise between now and 2027.
These forecasts also assume a sharp reduction in the ratio of costs to income. Overall, the expectation is for earnings per share (EPS) to increase from the 6.3p reported in 2024 to 11.3p in 2027.
Analysts are also expecting a dividend of 4.8p a share in 2027. If they’re right, it implies a forward yield of 5.1%. This is likely to appeal to income investors. Of course, there can never be any guarantees when it comes to payouts.
Too good to be true?
However, if I’m honest, these forecasts appear too optimistic to me. A 52% increase in post-tax earnings from 2024 to 2027 seems unlikely, especially for a bank that has such a narrow geographic concentration. A specific problem for Lloyds is that a weakening of the UK economy could lead to a rise in bad loans and a general reduction in new business. This feels like a major risk to me.
In my opinion, the bank’s valuation is becoming stretched and the recent rally could falter soon. That’s why I think there are better opportunities to think about elsewhere in the sector, including among the FTSE 100’s other banks.
