Will 2015 see Lloyds return to the dividend list?

22nd December 2014

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Steve Clayton of fund and stockbroker Hargreaves Lansdown anticipates that 2015 will be the year when Lloyds Banking Group makes a decisive return to the dividend list, having been absent since mid-2008. He explains why…

Most analysts are predicting a token payment will be declared for the current financial year, but next year they see the dividend stepping up to meaningful levels. Consensus has Lloyds paying 1.1p for 2014, 2.9p for 2015 and then 4.1p in 2016. If those analysts are on the money, Lloyds would yield over 5% in 2016 if the share price were to remain at the current 78p.

The average dividend forecast of the nine analysts that have made a prediction for 2017 is 5.3p per share, which, if it happens, will be a yield of 6.7% on stock bought at the current price.

In a SIPP, or an ISA, there would be no further tax to pay. All this is far from assured, and indeed some analysts are predicting no dividend for next year. Nevertheless I believe 2015 will be the year it becomes clear whether Lloyds can become the cash-cow management envisage.

Let’s look at where we are now. Ever since the financial crisis, Lloyds has been either in theatre, or in the recovery suite. Their recent Strategy Day revealed a bank that was off the respirator, only making occasional use of walking aids and frankly now just waiting for the consultant to come around and say they were good to go home.

Take the balance sheet for example. The volume of impaired loans has more than halved to 4.5% of the value of closing advances, since 2011, whilst the amount set aside to cover any unrecoverable part of these loans has risen from 47% to 57% of their value. Given how much of Lloyds’ lending is secured, that looks like a conservative level of provisioning.

The loan book is behaving itself quite nicely these days; Lloyds view of a typical year sees a charge of circa 0.4% of the overall loan book to be taken against bad debt. This level of impairment hasn’t been seen since the middle of last year and the last few quarters have seen bad debts costing more like 0.2% per annum.

Underlying profits in the first nine months were up 35% to £6.0bn and cash costs were down usefully. Equity on the balance sheet, in other words the reserves available to cover bad news at shareholders’ expense, is up to 12% of Risk Weighted Assets, comfortably in excess of regulatory requirements.

Lloyds’ vision of the future is to be a large, but simple bank providing everyday banking services to predominantly UK citizens and businesses. The problem is that the market for those services is pretty well supplied, so growth will be linked as much to wider economic growth as it is to Lloyds’ attempts to snaffle market share from its rivals. The flip side is, that if the business is broadly plain vanilla stuff, largely conducted close to home with customers the bank already knows, then the risks for the business could be more manageable.

In the Bank of England’s Stress Tests, Lloyds was found to have sufficient capital to hopefully withstand a Doomsday scenario of sharply rising unemployment, inflation, interest rates and collapsing house prices and stock markets; a sort of Greatest Hits of the last three decades’ economic traumas. However, the pass was narrower than one might have hoped for, but as the Bank acknowledged, the Dec 2013 starting position used for the exercise took no account for the profits retained since then, nor the ongoing work to reduce riskier assets within the business, and so Lloyds was deemed to be fit for purpose, with no special measures required to be taken to further lift capital reserves.

This means, fingers crossed, that a decent share of the profits could be returned to shareholders as dividends, given the starting point of Core Tier One capital of 12%. And that is why I think Lloyds might surprise on the upside this year.

The way the economy is behaving, the business could prove robust and those future dividends should start to feel more and more tangible to the market. If the market starts to believe that the sort of payment some analysts are suggesting for 2017 is really a possibility, then income-seekers could come flocking. However, the emphasis needs to be on the longer term and, as with all dividends, these are variable and not guaranteed.

Nothing is without risk – PPI redress costs spring to mind here – and an election bring further uncertainty. But I think that a simpler, less risky Lloyds, run for the long term, could be a really interesting income proposition for the next few years.

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