The Lloyds (LSE: LLOY) share price is one of the most-watched in the FTSE 100. Boasting a £33bn market cap, Lloyds is also one of the largest financial institutions in the UK.
There’s been one big reason in particular I’ve had my eye on the banking giant in recent days: interest rate cuts.
Interest rates heading down
All eyes were on the Bank of England yesterday (7 November) as the UK central bank cut interest rates by a further 25 basis points to 4.75%.
That’s the second cut from the recent 5.25% highs, which may be welcome news to those with mortgages. However, the central bank has flagged there are fewer reductions to come as inflationary pressures remain.
Interest rates indirectly have an impact on many parts of the economy. For banks, however, they can have a much more direct impact.
Net interest margins
One of the key metrics banks are judged on is the net interest margin (NIM). This measures the difference between interest income earned on lending activities (like mortgages) and the interest paid on its capital base, like deposits and borrowings.
It’s essentially a measure of profitability. The higher a bank’s NIM, the greater its efficiency in generating income off of its funds.
Watching the price
Falling interest rates can compress a bank’s NIM because the interest earned on loans tends to drop faster than the rates it pays to depositors. That means I’m watching Lloyds the share price closely after yesterday’s Bank of England decision.
Shares in the bank closed broadly flat at 54.5p although many investors anticipated the rate cut ahead of time. That means the Lloyds share price has now gained 13.5% this year compared to 5.4% for the broader Footsie.
Despite beating profit estimates for the quarter ended 30 September 2024, Lloyds’ NIM narrowed from 3.08% to 2.95%. Rival NatWest reported a 13 basis point increase in NIM to 2.18% for the same period.
Interestingly, HSBC cited higher interest expense on its liabilities as a key factor behind its 24 basis point decrease in NIM to 1.46% in the third quarter.
Would I buy?
All of this interest rate action makes for interesting viewing. The key question for me is whether or not there’s a buying opportunity in the UK banks. After all, Lloyds has a reputation for stability and paying a solid dividend.
The Lloyds share price is sitting near a six-month low with a price-to-book ratio of 0.75. That means investors buying today would be paying less than the book value of the bank’s assets.
This could suggest that it’s undervalued. But I think it could also mean investors are wary of weaker profitability or losses from bad loans.
I’m not prepared to buy at the current price. I think there’s potentially more pain to come for the big banks in terms of their loan books, and competition is fierce. With falling interest rates, we could see further pressure on deposit rates as banks fight to keep depositors from switching to better deals elsewhere.
