£10,000 invested in Lloyds shares 3 years ago is now worth…

Lloyds (LSE:LLOY) shares are up 50% over three years. The FTSE 100 stock is close to its five-year highs, but there’s been a lot of volatility since the pandemic. It’s been an unloved stock, and one that has been heavily impacted by macroeconomic challenges.

Nonetheless, £10,000 invested three years ago is now worth £15,000. What’s more, a shareholder would have received around £1,700 in dividends during the period. All in all, it would have been a pretty strong investment return.

Reflecting economic strength like no other

As the UK’s largest mortgage provider, Lloyds’s performance and share price are closely tied to the country’s economic health. Historically, the stock has been sensitive to macroeconomic shifts, particularly in the housing market and the broader financial backdrop. However, recent developments have bolstered investor confidence, driving the share price higher.

Recession risks have receded, with the UK economy showing resilience despite earlier concerns. This has alleviated fears of widespread defaults or significant impairments on Lloyds’ mortgage book. Additionally, the worst-case scenarios for loan impairments have largely passed, with the bank reporting improved arrears rates and a stable loan-to-value ratio of 43.7% in 2024. More than two-thirds of its book was on a pay rate of higher than 3%.

Net interest income, a key driver of profitability for banks, remains elevated compared to historic averages. While Lloyds’ net interest margin has declined slightly to 2.95% in 2024, it continues to benefit from higher interest rates, which have supported earnings growth. The bank’s mortgage portfolio expanded by £6.1bn in 2024 to £312bn, with a 20% flow market share, reflecting its dominant position in the sector.

These factors, combined with a rebound in the first-time buyer market and improved lending to energy-efficient properties, have contributed to Lloyds’ improving share price. While challenges remain, including potential fluctuations in mortgage rates and economic uncertainty, the current environment supports a positive outlook for the stock.

Don’t worry about interest rates

Some of my peers talk about concerns of falling margins, but I’m not worrying. Lloyds operates a structural hedge to mitigate interest rate volatility and protect margins. In 2024, the hedge generated £4.2bn in total income, a significant increase from £3.4bn in 2023, reflecting the benefits of reinvesting balances in a higher rate environment. This contributed to a net interest margin (NIM) of 2.95%, slightly down from 3.11% in 2023.

The hedge’s notional balance stood at £242bn at the end of 2024, with a weighted average duration of approximately 3.5 years. Analysts project further growth in hedge earnings, with estimates of £1.2bn and £1.5bn increases in 2025 and 2026, respectively. This strategic tool not only safeguards Lloyds’ profitability but also positions the bank to capitalise on future opportunities.

A ‘slam dunk’ buy?

I’ve been bullish on Lloyds for some time. However, I’m no longer as bullish as I used to be, believing it to be undervalued by around 15%. In other words, there’s a smaller margin of safety than there was previously. Given it’s also one of my larger holdings, I won’t be adding more. Nonetheless, I’ll continue to collect the dividend and hope that it continues to push towards fair value.

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James Fox has positions in Lloyds Banking Group Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.