The Lloyds (LSE:LLOY) share price has leaped into 2025, with the stock’s 26% gains outpacing the FTSE 100’s 4% rise. However, it has not been a smooth few months for the bank. So, why has it surged?
What’s going on?
In February, Lloyds nearly tripled its provision for the car finance mis-selling scandal to £1.2bn. This move significantly impacted its annual profits, which fell from £7.5bn in 2023 to £5.97bn. The scandal stems from discretionary commission arrangements (DCAs), where car dealers were incentivised to inflate interest rates without informing customers. This practice, banned in 2021, is now under scrutiny by the Financial Conduct Authority (FCA), with potential compensation claims dating back to 2007.
The Supreme Court’s upcoming ruling in April could further escalate the issue. If the Supreme Court upholds the October 2023 Court of Appeal decision, which expanded the scope for compensation claims, Lloyds and other lenders could face billions in liabilities. Analysts estimate the total industry-wide cost could reach £30bn–£44bn. This echoes the infamous payment protection insurance (PPI) scandal, which cost Lloyds £21.9bn alone. The Court has rejected the Chancellor’s attempt to keep compensation payments to a minimum.
Despite these challenges, Lloyds has maintained investor confidence through a £1.7bn share buyback program and a £1.28bn dividend payout. CEO Charlie Nunn has emphasised the bank’s strong core performance, highlighting growth in other business areas. These factors, coupled with the fact that Lloyds hadn’t experienced the same appreciation as its peers, is part of the reason the bank stock has pushed higher.
The macroeconomic case is improving
Personally, I think Lloyds is trading closer to where it should be, regardless of the motor finance case. That’s because the macroeconomic case for Lloyds is improving as recession fears subside and the UK economy shows signs of stabilising.
Economic growth, though modest, is supported by higher government spending and wage growth. Falling interest rates are expected to boost mortgage demand. The UK mortgage lending market is forecast to grow by 3.1% in 2025, up from 1.5% in 2024. This trend should benefit Lloyds, given its strong position in the UK housing market.
Additionally, Lloyds’ strategic hedging strategy continues to provide stability. In 2024, Lloyds’ sterling structural hedge delivered £4.2bn in total income, a significant rise from £3.4bn in 2023. This should rise further in 2025. Despite this, the net interest margin (NIM) slightly dipped to 2.95% from 3.11% in 2023, as the bank navigated challenges such as deposit churn and asset margin compression.
However, the NIM would have dropped much further if it wasn’t for the hedging. And what we’re seeing is something of a Goldilocks scenario. Loan demand is rising, net interest income remains elevated, and the economy isn’t providing any unwanted worries.
Personally, having already build a sizeable position in Lloyds, I’m not buying more right now. Risks are currently elevated, but I believe it could still be undervalued, potentially significantly.
This post was originally published on Motley Fool
