Earlier this weekMark Carney, the Bank of Englands governor, caused a stir after he warned that the risks of Britain leaving the EU could include a technical recession as the uncertainty following the event may cause both growth and sterling to fall and unemployment to rise.
Whether or not the UK will slump into a recession following a leave vote remains to be seen, but its clear that if the UK does tear itself away from the European block, there will be a certain amount of economic uncertainty in the weeks and months following.
Uncertainty generally leads to a more cautious stance by both consumers and businesses, which will be bad news forLloyds (LSE: LLOY).
Housing boom
As the UKs largest mortgage lender and one of the countrys largest retail banks, Lloyds growth is highly correlated to the UKs economic performance.
And over the past five years, Lloyds has received a huge boost from mortgage lending asthe UKs housing market has taken off and house prices have surged to record levels. This growth has helped Lloyds achieve one of the best returns on equity and capital ratios in the European banking industry.
For the three months ended 31 March 2016, Lloyds net interest margin, the difference between interest income generated and the amount of interest paid out to depositors, ticked higher by 10 bps to 2.75% from 2.64% as reported last quarter. The banks cost-to-income ratio fell to 47.4%, down from 47.7% a year ago, return on equity came in at to 13.8% and Lloyds capital reserves expanded to 13%, from 12.8% at the end of last year.
Whats more, Even if these metrics dont improve over the next 12 months, Lloyds earnings will still get a boost from the banks decision to buy back so-called enhanced capital notes, which will give the lender a 900m cash injection over the next four-and-a-half years.
Following the banks sector-leading performance, investors have been pushing Lloyds valuation higher, and the bank now trades at a premium to the wider European banking sector.
Specifically, Lloyds is currently trading at a price-to-tangible-book value of 1.3 compared to the broader European banking sector, which is trading at a price-to-tangible-book value of below 0.8. Lloyds UK peerBarclays trades at a price-to-tangible-book ratio of 0.6.
If the UKs lending and economic growth stalled, its likely Lloyds valuation could fall back into line with its European peers as investors reconsider the groups growth prospects. At a valuation of 0.8 times tangible book, Lloyds shares would be worth around 42p, more than 30% below current levels. If the banks valuation falls to a similar level as that of Barclays, the shares would be worth 31.2p, 52% below current levels.
The bottom line
So, theres a real risk that if the UK leaves Europe shares in Lloyds could fall by as much as 52%, which would be a disastrous result for shareholders.
Still, City analysts believe that Lloyds has the capacity to pay 10p per share to investors via dividends, excluding any special payouts during the next two years. At 31.2p this cash return would translate into a dividend yield of 32%. Of course, Lloyds management may decide to save cash if the banks growth slows.
To help you evaluate Lloyds for yourself, our top analysts have put togetherthis report, thatguides you through the10essential steps you need to take to become a stock market millionaire.
Thereport explainshow spending just 20 minutes a month could help you create a portfolio that could bring you closer to financial freedomfor life.
Click hereto check out the report – it’s completely free and comeswith nofurther obligation.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
