6.5% dividend yield! Should I join these investors and buy cheap Lloyds shares?

The Lloyds Banking Group (LSE:LLOY) share price is a long distance away from its 2023 high point. At 43p per share, it’s a full 20% cheaper than it was when it peaked in early February.

Worries about the downtrodden UK economy and how it could affect the FTSE 100 firm’s profits have pulled the shares lower. However, some might argue that the prospect of weak revenues and soaring bad loans are now baked into the bank’s valuation.

Strong buying interest from Hargreaves Lansdown customers suggest the mood might be changing. It is the fourth-most-purchased share in the past seven days, accounting for 0.93% of all buy orders.

Lloyds shares certainly look cheap on paper. They now trade on a forward price-to-earnings (P/E) ratio of 5.7 times. The Black Horse Bank’s market-beating 6.5% dividend yield is also very attractive.

Should I also buy its shares for my portfolio today?

Double trouble

A steady stream of interest rate raises have been a huge boost to the banks since the end of 2021. At Lloyds, net income soared another 11% between January to June, to £9.2bn, as the difference between the interest it charged borrowers and offered its savers widened.

The trouble is that higher interest rates create problems for banks as well as benefits. Demand for credit dips if consumers find it more unaffordable, and loan impairments can soar as existing borrowers struggle to make ends meet.

These twin headwinds were also obvious in the firms’ latest financials. Loans and advances dropped 1% to £450.7bn in the six months to June, while credit impairment charges of £662m were higher than forecast and up significantly from £381m a year earlier.

Lloyds is especially vulnerable to interest rate hikes given its position as the UK’s largest home loans lender. Trade body UK Finance says that 81,900 homeowner mortgages were in arrears of 2.5% or more of the outstanding balance in quarter two. That was up 7% from the prior three months.

Lloyds shares: best avoided?

Predictions of a long economic downturn in Britain should serve as a huge red flag for potential Lloyds investors. And especially as the Bank of England’s rate-rising cycle is tipped to be ending soon.

The Black Horse Bank faces threats elsewhere, too. Rising public frustration from the Financial Conduct Authority on lacklustre savings rate increases is one concern. It means that sector reforms could be coming unless the industry pumps up what it pays savers.

Growing costs don’t attract as much attention when it comes to talking Lloyds shares. But it is something that share pickers also need to pay close attention to. Operating costs spiked 6% in the first half, to £4.4bn, due to inflationary pressures and investment in areas such as digital.

As I say, Lloyds shares are cheap on paper. But I believe this low valuation is a fair reflection of the risks it exposes investors to. I’d rather buy other FTSE 100 stocks today.