Should I buy Lloyds shares before the ISA deadline?

Lloyds‘ (LSE:LLOY) shares reflect the health of the British economy more than any other UK bank. Lloyds has historically positioned itself as a domestic UK retail and commercial bank, with very limited international operations.

Its business is overwhelmingly centred on everyday UK customers through brands such as Lloyds Bank, Halifax, and Bank of Scotland. It exited most of its international businesses after the 2008 financial crisis and has leaned heavily into its role as a core domestic lender.

So what does this mean for investors? Let’s explore.

Is UK exposure a good thing?

We should start by accepting that the British economy doesn’t impact Lloyds in just one way. Growth, interest rates, credit quality, regulation, among others things, all impact the bank’s operations and eventually, it’s earnings.

Now, there’s something analysts, including myself and John Choong, have often referred to as the ‘Goldilocks Zone. One interpretation of this is when economics conditions are ‘just perfect’ for banks to thrive. In the UK, this would look something like strong and sustainable economic growth — anything above 2% — and interest rates sitting somewhere between 2%-3.5%. Let me explain why.

Strong economic growth — that 2%-plus threshold — is what drives loan demand. When businesses are expanding and consumers are confident, they borrow from the banks — expanding the loan book and contributing to long-term income generation (mortgages, personal loans, business credit lines). A sluggish economy suppresses that demand, and with Lloyds so heavily exposed to the UK domestic economy, there’s nowhere to hide.

But growth alone isn’t enough. The interest rate environment matters just as much, if not more. That’s because of the net interest margin — the difference between what Lloyds earns on loans and what it pays out on deposits.

When rates are too low — say, close to zero as they were for much of the 2010s — that margin gets squeezed. Lloyds can barely charge enough on the money it lends to make meaningful returns.

When rates move too high however, and the problems shift — this is what investors were worrying about as rates surged after the pandemic. Under these circumstance, borrowers start to struggle, defaults rise, and the credit quality of the loan book deteriorates. Mortgage holders on variable rates feel the pinch first, and given Lloyds is the UK’s largest mortgage lender, that’s an acute vulnerability.

It all comes back to the valuation

As with any investment, it’s all relative to the valuation. The current outlook for the UK economy is quite poor — circa 0.5% growth this year — and interest rates should be falling into the Goldilocks Zone, but the war in the Gulf has thrown that into doubt.

This probably isn’t the type of environment that makes Lloyds deserving of a premium valuation. And this, along with concerns about AI disruption in the wider economy, has contributed to a pullback from premium levels seen in January/February.

Today, the bank trades around 8.8 times forward earnings — down from as high 11 times. The forward dividend yield is also pushing 4.7%. In short, this is a more attractive entry point than it was six weeks ago — which is incidentally when I started selling my position in Lloyds.

So is it time for me to buy? I think it’s worth considering, but I feel there are better options elsewhere.

The post Should I buy Lloyds shares before the ISA deadline? appeared first on The Motley Fool UK.

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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.

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