Today I am looking at why income chasers could be left disappointed by Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US).
Capital strength a cause of concern
Despite the impact of extensive streamlining and cost-cutting at part-nationalised Lloyds, the business remains on a fragile financial footing as the fallout of the 2008/2009 financial crisis continues to haunt the business.
Indeed, the bank’s less-than-stellar capital position was exposed again by the Bank of England this week, giving investors further cause for concern after it scraped past the European Banking Authority’s minimum CET1 ratio in November — a reading of 6.2% barely surpassed the target of 5.5%.
According to Threadneedle Street, Lloyds “remains susceptible to a severe economic downturn”, a scenario that would assume interest rates of 6% and a 35% slump in house prices — the business is by a long chalk the country’s largest mortgage provider so the news does not come as a big surprise.
Lloyds still passed the examination, of course, and is not required to re-submit its capital plan unlike high-street rival the Co-operative Bank. But a capital ratio of just 5% under adverse financial conditions barely met the minimum 4.5% requirement, hardly giving the markets reason for cheer.
Bullish broker sentiment ignoring the risks?
Despite Lloyds’ rocky stress test results, however, City analysts still expect the Prudential Regulatory Authority (PRA) to give the business the thumbs up to start forking out dividends sooner rather than later, and have pencilled in a final dividend of 1.1p per share for this year.
And for 2015 the number crunchers expect Lloyds to shell out a total payment of 2.9p per share, in turn creating a chunky yield of 3.8% — by comparison the FTSE 100 carries a forward average of just 3.3%.
But even if the PRA allows the bank to crank its dividend policy back into action in the coming months, the scale of payouts at Lloyds could fall well short of estimates given the firm’s obvious need to bulk up its capital position.
Even though chief executive António Horta-Osório commented that the bank had “made further significant progress in strengthening our capital position” since late 2013, Lloyds still faces a multitude of problems which could whack dividend estimates, from a steady rise in legal penalties — most notably from the mis-selling of PPI — through to the threat of economic contagion from Europe.
Although Lloyds is undoubtedly on a stronger financial footing than that of five years ago, a consequence of an improving British economy and huge restructuring across the business, the resurrection of Lloyds’ dividend policy is by no means a foregone conclusion in my opinion.