How will tremors in the UK housing market impact Lloyds shares in 2023?

Lloyds (LSE:LLOY) is the UK’s largest mortgage lender, claiming nearly one-fifth of the market. Due to the bank‘s greater domestic focus than FTSE 100 rivals such as Barclays and HSBC, Lloyds shares have significant exposure to Britain’s wobbly housing market.

The group expects UK house prices will fall 7% this year. However, in a worst-case scenario, it isn’t ruling out the possibility of a devastating 40% crash.

So, what does this mean for the Lloyds share price? Here’s my take.

Cracks in the foundations

The cost-of-living crisis is taking its toll. According to the consumer group Which?, an estimated 700,000 households missed a rent or mortgage payment in April. Taking renters out of the picture, 3.1% of the country’s mortgage holders failed to meet their obligations last month.

But the bad news doesn’t end there. The ONS anticipates 1.4m households will face higher remortgage rates in 2023, and plenty of fixed-rate deals are due to mature throughout 2024 too.

These gloomy statistics raise the spectre of the 2008 financial crisis. A rising number of property owners in mortgage arrears would deal an unwelcome blow to Lloyds’ income. To compound problems, the bank could ultimately have to force a higher number of repossessions.

If domestic real estate prices decline, that means the group will be left with assets that are worth less than they were. Such concerns aren’t confined to speculation about the future either. In FY22, Lloyds made a credit impairment charge of £1.5bn for potential bad debts. This reduced the bank’s pre-tax profit to £6.9bn — flat on the year before.

Interest rates

Despite the risks facing Lloyds shares, there’s another side to the coin. Rising interest rates are a key factor behind the housing market’s woes. But tighter monetary policy also helps bank stocks, like Lloyds.

Results for the first quarter of the year showed a 20% uptick in the group’s net interest income (the difference between what the bank charges for loans and mortgages versus what it pays to savers). That boosted the bank’s pre-tax profit 46% to £2.3bn, beating the consensus £2bn forecast from City analysts.

So far, Lloyds appears to be weathering the potential financial storm. It stated it was only seeing a “modest” increase in borrowers falling into arrears, suggesting there’s no urgent cause for alarm yet.

Should I buy Lloyds shares?

I think it’s hard to deny a potential decline in UK house prices could have a significant impact on the Lloyds share price. However, the magnitude of any such fall will be critical. It’s likely the market has already priced in some of the risks, so it’s surprises to the downside that would give me real cause for concern.

As a shareholder, I’m pleased to see recent financial results demonstrate the bank’s resilience. In addition, it’s worth noting that Lloyds is in a significantly better position than it was in 2008. Stricter lending conditions and a 14.1% CET1 ratio suggest it’s sufficiently well capitalised to withstand some big shocks.

Given the risk/reward profile, I’m comfortable with my present exposure to the stock. I’ll continue to hold my shares, but I won’t add more until the future direction of the UK housing market becomes a little clearer.