Lloyds shares could exit penny stock status as interest rates advance

The Lloyds (LON: LLOY) share price has had a long-term problem ever since the financial crisis of 2008.

For the past 14 years, the 257-year-old institution has remained a penny stock. It’s rarely come close to breaking the 100p resistance level, as investors sell off shares before it reaches this critical point. Despite being a FTSE 100 constituent with a £34 billion market cap, penny stock status is inalienably connotated with high-risk, volatile investments.

But with the economic landscape changing, Lloyds shares could soon break through this important psychological barrier.

Lloyds share price: full-year results

The FTSE 100 bank released full-year results on 24 February, the same day as Russia launched its invasion Understandably, this overshadowed the bank’s impressive financial recovery after the devastating impact of the covid-19 pandemic.

Like its contemporaries — HSBC, Barclays, and NatWest — the UK’s largest banking group reported a bumper profit recovery, with pre-tax profits up 425% from £1.2 billion in 2020 to £6.3 billion in 2021. Profits were boosted by a £1.2 billion release of provisions set aside for bad pandemic loans which never materialised. Net income also rose, by 9% to £15.8 billion.

However, on results day, Lloyds shares fell by 11%, as it missed the Refinitiv average analyst profit forecast of £7.2 billion, while the FTSE 100 lost 291 points as investors fretted over the financial implications of Russia’s invasion.

However, Lloyds had to repay £1.3 billion in remediation charges due to historic fraud costs, including a £790 million charge at its Reading HBOS location. The bank controversially acquired HBOS during the monetary bloodbath of 2008, after a shareholder vote which was subsequently followed by lawsuits crying foul play.

But crucially, the sum ‘reflects the Group's estimate of its full liability, albeit significant uncertainties remain.’ A line of sorts can now be drawn under the mess. And with deposits up by £25.6 billion to £476.3 billion, it’s in a position of financial strength to increase lending in 2022.

Lloyds share price: rising interest rates

Lloyds’ mortgage book currently stands at £293.3 billion, having increased by £16 billion in 2021. With the ‘race for space’ still ongoing as the UK undergoes its remote working revolution, this could increase to over £300 billion by the end of Q2 2022.

And yesterday, the Bank of England increased the UK’s base interest rate for a third consecutive time, to 0.75%. With the Consumer Prices Index inflation rate at 5.5%, the Bank has thrown out its previous inflationary predictions, saying that it could now be ‘several percentage points’ higher than 7.25% later this year.

While the Bank remains powerless against the rising costs of imported energy and food, the pressure to continue to raise rates to stave off a wage-inflation spiral remains intense. Capital Economics Chief Economist Paul Dales believes the bank rate ‘will be increased to 1.00% in May and will reach 2.00% next year.’ Meanwhile, HSBC is predicting a rise to 1.25% as soon as August.

According to UK Finance, today’s rate increase alone will add £26 to an average UK tracker mortgage customer’s monthly repayment. If the bank rate reaches 1.5%, £129 would be added to the monthly bill.

Of course, with 74% of mortgage holders on fixed rate deals, the effect of rate rises will filter through the financial system slowly. But Lloyds knows this, forecasting that its return on tangible equity will rise to more than 10% by 2024, and 12% by 2026.

But rising interest rates also come with risks. According to the Office for National Statistics, the average UK house price now stands at £275,000, while the median pre-tax wage stands at £31,772pa.

With an escalating cost-of-living crisis, interest rate rises on bloated mortgage amounts could see households default on their debts, slide into negative equity, or lose their incomes in the event of a recession.

But historically, the Lloyds share price strongly tracks UK interest rates. Unlike its competitors, it has no international operations. In January 2008, the bank rate was at 5.5% but had been reduced to 0.5% by March 2009. It’s no coincidence that Lloyds has been a penny stock since.

However, before the financial crisis, the bank rate hovered around 5%, and the Lloyds share price was worth several times more than its current value.

And as the bank begins its £2 billion share buyback programme, the long-awaited recovery closer to pre-crash norms becomes ever more realistic.

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*Based on revenue (published financial statements, 2022).