The Lloyds Banking Group (LSE: LLOY) share price has fallen by 30% over the last year, lagging the FTSE 100 by 20%. Lloyds hasn’t paid out a dividend since September 2019 and is only expected to declare a tiny final dividend for 2020.
Despite all of this, Lloyds’ depressed valuation has got me interested. I expect the bank’s profits and dividend to recover strongly in 2021. Broker forecasts for this year suggest the stock could offer a dividend yield of more than 4%, with another big increase expected in 2022.
Why I like Lloyds
High street banks have had a problem with low interest rates in recent years. Put simply, low rates and strong competition among lenders have led to lower profit margins on mortgages and loans.
I don’t think there’s any end in sight to low interest rates. But I do think banks are likely to find other ways to repair their profitability. One possibility is that competition will lessen in the mortgage market, resulting in higher mortgage rates. For Lloyds, which has around 20% of the UK mortgage market, this could make a big difference.
Another area of potential growth is wealth management. Lloyds is expanding into this sector through a joint venture with City firm Schroders. Looking after rich people’s assets is generally more profitable than providing standard banking services, so this too could boost profits over time.
Growth could be a struggle
Lloyds’ big share of the UK mortgage market attracts me. I expect it to be a reliable source of income. But the bank’s large size and UK-only focus does present some challenges. I think these are behind Lloyds’ weak share price.
In a mature market like the UK, growth opportunities could be limited. As far as I can see, Lloyds needs to steal business from its rivals to get bigger. That won’t necessarily be easy.
Another concern is the impact of the coronavirus pandemic. Broker forecasts for 2020 suggest earnings fell by more than 50% last year, compared to 2019. Profits aren’t expected to rise above 2019 levels until 2022.
If the bank can deliver on these forecasts, then I think the shares look cheap. But this isn’t guaranteed. As far as I can tell, no-one really knows how quickly the UK economy will recover when government support measures are withdrawn.
One risk I can see is that unemployment will rise sharply after the furlough scheme ends. That could see more borrowers fall into arrears with their mortgages. Similarly, I think there’s a risk we’ll see a surge of small business bankruptcies. This could hit Lloyds’ corporate banking profits.
Lloyds share price: at the right level?
Of course, Lloyds hasn’t overlooked the potential for increased losses. The accounting rules which apply to banks require them to estimate expected future losses and book these against their profits.
The bank included a £4.2bn impairment charge in its results for the first nine months of 2020, reflecting expected losses from the pandemic. If that’s as bad as it gets, then Lloyds looks good value to me at a share price of around 40p. I’d be happy to add a few to my dividend portfolio.