Lloyds shares: headwinds to consider for Q4 2023

Lloyds shares (LON: LLOY) remain one of the highest volume stocks on the FTSE 100. And the bank’s share price is down by 9.8% year-to-date to 42.5p, now offering a dividend yield of 5.9%.

This could be an attractive entry point for passive income dividend stock investors — especially given Lloyds’ tendency to trade within a range of approximately 42p-52p since mid-2021.

However, there are some headwinds to consider.

Lloyds share price: Q2 results

Lloyds’ Q2 earnings just missed analyst estimates, with underlying net income down to £4.52 billion. However, the dividend was increased by 15% to 0.92p per share, an unexpected positive in otherwise relatively stable results.

Further, net interest margins are now expected to be over 3.1% for the full year, an upgrade from the 3.05% previous guidance. And it anticipates a return on tangible equity of more than 14%, compared to 13% previously. Beyond this, the FTSE 100 bank reported a CET1 ratio of 14.2%, a cut above the standard 12.5% target, signifying strong financial resilience.

It’s also worth noting that Lloyds boasts a relatively resilient customer base —its average mortgage customer has an average loan-to-value ratio of 42%, making current house price falls unlikely to present too much of a problem for the majority of its clients.

Of course, past performance is not an indicator of future returns.

Headwinds to consider

However, there are some good reasons why Lloyds’ share price might be struggling.

Underlying impairments rose from £243 million to £419 million. The FTSE 100 bank is the largest mortgage lender in the UK with circa £300 billion of lending on its books, and the base rate already stands at 5.25%, with markets expecting a terminal rate of circa 6%. While Lloyds customers may be more resilient than average, CE Charlie Nunn notes that 200,000 remortgaging customers are coming into a financially difficult time.

Indeed, the bank’s expected credit losses forecast sees Lloyds allocate allowances of £3.7 billion in an upside scenario, and as much as £10.1 billion in a worst case scenario.

Lloyds also has no international operations and is therefore highly exposed to the UK domestic economy. While the Bank of England is no longer forecasting a recession in 2023, these forecasts seem to change with the wind. And with rates elevated compared to the post-2008 period, continued deposit outflows and falling loan growth through Q4 and beyond seem likely.

Further to this, higher rates don’t just come with a higher chance of defaults. They also more strongly incentivise customers to seek out the best lending deal, forcing Lloyds and other mortgage providers to cut their rates to stay as competitive as possible — as evidenced by Moneyfacts data showing that more lenders cut rates than increased them last week.

And then there’s the windfall tax fear to contend with. While the UK’s banking sector has so far avoided surcharges on interest-driven profits — which arguably are not the result of good business but simply luck — suffering mortgagees with low equity in their homes have been hit much harder than other segments of society by rising rates. This could make it politically attractive to hit the banks with an additional tax.

Italy has already broken the windfall tax taboo — earlier this month, the country imposed a 40% tax on profits earnt from higher interest rates, which it was then forced to water down to be capped at 0.1% of assets after the inevitable sell-off.

Considering increased competition, the reduced pool of customers who can qualify for loans at higher rates, and the political fear of extra taxation, Lloyds could be caught between a rock and a hard place.

However, the bank also thinks that the base rate will fall to 2.6% by 2026, which could see Lloyds benefit from bigger profits than in the sub-1% era, but without the problems associated with higher rates.

For long-term investors seeking a solid dividend-paying FTSE 100 company, this could make Lloyds attractive — though as ever, there is a bear for every bull.