The Lloyds Banking Group (LSE:LLOY) share price has taking a beating in recent months due to the ongoing motor finance scandal. However, savvy investors might see this as an opportunity rather than a setback. Here’s why Lloyds shares could be poised for a recovery and more in 2025.
Strong fundamentals
Despite concerns about the size of the potential fine resulting from mis-sold motor finance, Lloyds’ core business remains robust. The FTSE 100 bank’s performance in the third quarter of 2024 was solid, with growth in income alongside continued cost discipline and strong asset quality. This resilience in the face of a more challenging macroeconomic environment speaks volumes about the bank’s underlying strength.
A lending renaissance
As interest rates fall, Lloyds will likely finds itself perfectly positioned to capitalise on a transformative lending landscape. The reduction in borrowing costs should trigger a resurgence in credit demand, particularly in mortgages. The bank is the country’s largest mortgage lender, and mortgages typically account for around two-thirds of its loan book.
The simple reason behind this is that homeowners and first-time buyers, previously constrained by prohibitively expensive financing, will suddenly find property acquisition significantly more attractive. Given Lloyds’s extensive mortgage infrastructure, the bank could be able to scale loan approvals more quickly than peers.
Moreover, Lloyds’s loan book could grow as a result of increasingly bullish sentiment within small and medium-sized enterprises. Business finance is a smaller part of Lloyds’s portfolio, but it will certainly benefit from supportive trends here.
The hedging windfall
Now, I’ve seen several of my peers highlight that falling rates will see a contraction of net interest margins. But that’s not necessarily the case because Lloyds, like other banks, operates a strategic hedge. This hedge protects the bank from sudden central bank interest rate changes, but it can have a net positive impact on earnings when interest rates are falling.
In short, when interest rates are higher, banks are replacing their low-yield fixed income investments — like bonds — with higher yielding ones. In fact, the latest Fitch rating highlighted Lloyds’s structural hedge as the main factor underpinning the bank’s robust earnings.
Lloyds generated around £1.9bn in hedging income in the first half of 2024, with an expectation of more than £700m in the second half. Lloyds’ structural hedge income is expected to drive stronger earnings in 2026 as well, and this could be underappreciated by the market.
The bottom line
Investors shouldn’t overlook the motor finance scandal. The fine is set to be bigger than originally anticipated and the ongoing uncertainty will continue to exert downward pressure on the bank. Coupled with recent downward revisions to UK economic growth, those are risk factors for this stock.
However, Lloyds shares should bounce back and push higher again driven by a resurgence in loan demand and strategic hedging. If Lloyds wasn’t already well represented in my portfolio, I’d buy more.
This post was originally published on Motley Fool
