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Lloyds Banking Group (LSE:LLOY) shares have soared in value after a slow start to the year. At 55.9p per share, FTSE 100 Index Banking costs are now 17% higher than on New Year's Day.
By comparison, the Footsie index is up a modest 6%. But I am not tempted to buy the bank today. In fact, I think a sharp correction in the share price could be on the way.
Here are three reasons why I think Lloyds' share price could crash.
Disabilities on the rise
The UK's short- and medium-term economic outlook remains bleak. Major economic bodies expect GDP to expand by around 1% over the next two years. Structural problems such as high public debt, trade barriers and labour shortages mean that growth could remain weak beyond the short term as well.
Cyclical stocks such as Lloyds are likely to struggle to grow revenue in this climate, but that is not the only danger. Tough economic conditions mean credit impairments could also continue to rise, even if interest rates fall.
On the plus side, Lloyds' bad loans fell to £70m in the first quarter, from £246m a year earlier. The bank is not out of the woods, though. And its huge exposure to the mortgage market in particular means the figure could suddenly rise again.
That's because mortgage rates are set to rise for 3 million households between now and 2026, according to the Bank of England (BoE). Of this number, 400,000 will pay 50% more than they do now, the bank says.
As I say, Lloyds is particularly immune to this threat: it makes around a fifth of all mortgage loans in the UK.
Crushed margins
Lloyds' chances of boosting profits will be even more difficult if – as the market expects – interest rates are likely to start falling from late summer or early autumn.
Banks make most of their profits by charging a higher interest rate than they offer to savers. This is known as the net interest margin (NIM), and is highly sensitive to the Bank of England's lending benchmark.
Lloyds' margins are falling even before the Bank of England has started cutting rates. In the first quarter, its net interest margin fell 27 basis points to 2.95%. Net interest income therefore fell 12% to £3.1bn.
Ambitious rivals
Margin declines could be even more severe in the future, and not just because of interest rate cuts. Growing competition from digital banks and new banks is also increasing pressure on established banks’ net interest margins.
Fortunately for Lloyds, its brand is exceptionally strong and it has a significant (albeit declining) presence in the retail market. It therefore has a better chance of maintaining and growing its customer base than many other banks.
However, the threat from new entrants remains serious and the outlook could become even more complicated if, as expected, they increase their financial power by issuing shares. Monzo, Revolut and Oaknorth are all expected to launch their own IPOs sooner rather than later.
This is what I'm doing
On paper, Lloyds shares still look cheap despite recent gains. They trade at a forward price-to-earnings (P/E) ratio of just 8.6 times.
However, I believe the risks of owning the bank outweigh the potential benefits, so I am currently buying other low-cost FTSE 100 stocks.
