Lloyds Shareholders to be Rewarded with 5% Yield in 2016

Equity analysts are disappointed Lloyds income continues to suffer from the mis-selling of PPI - but confident that the bank will increase its dividend payouts this year and next

Erin Davis 3 August, 2015 | 1:34PM
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Lloyds’ Banking Group’s (LLOY) first-half results brought some bad short-term news but reinforced our positive long-term view on the bank. We were especially disappointed to see that Lloyds has had to put aside £1.4 billion of additional provisions for claims relating to the mis-selling of PPI insurance, bringing total provisions to a whopping £13.4 billion.

Political risks are more material than PPI payouts

The bank’s paltry £717 million half-yearly net income available to common shareholders also included a £745 million loss on the sale of TSB and £435 million of other misconduct charges. Still, the bank’s underlying performance was impressive: underlying return on equity was around 15% as we calculate it, annualised loan losses were a mere 0.07% of loans, and the underlying cost/income ratio was a market-leading 48%.

This reinforces our view that Lloyds can earn a 13% return on tangible equity in the medium term, supporting its narrow moat rating. We plan to maintain our 98p fair value estimate.

Despite the weighty misconduct charges, Lloyds reported a 50-basis-point improvement in its fully loaded CET1 ratio to 13.3%, paving the way for the more material dividends we’ve been predicting for 2015. Still, we were not overwhelmed by the bank’s 0.75p interim dividend and think that our full-year dividend estimate of about 2p seems about right. We think the payout will be more substantial in 2016 – we’re pencilling in 3.4p in our base case and 4p in our upside scenario – implying a forward yield of 4%-5%.

While we’re pleased with the underlying results, we think that events in the second quarter highlight the near-term risks that Lloyds faces. The £1.4 billion of additional PPI charges were more than we had expected, and management provided no assurances that more charges don’t lie ahead.

Our fair value estimate includes £2 billion of additional litigation and regulatory charges over the next several years. While we consider this estimate to be preliminary, we don’t see this as a major risk to our fair value estimate – tripling it would erase only 3% from our valuation. Political risks are more material.

In July, the U.K. announced plans to reduce the U.K. bank levy and replace it with an 8% surcharge on bank’s U.K. profits; Lloyds guided that its medium-term tax rate is likely to be near 30%.

We think this will hit Lloyds harder than other large U.K. banks, as its operations are very U.K.-focused, and the increase in taxes fully offsets savings from the lower bank levy, as well as income accrued and improved performance since our last update.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Lloyds Banking Group PLC52.25 GBX0.42Rating

About Author

Erin Davis  is a senior banking analyst for Morningstar.