Since bottoming out six years ago and after a Government bailout, Lloyds shares have rebounded some 220 per cent although it has not been a smooth ride with material rises and falls being seen as investors reacted to a trove of good and bad headlines.
Performance of stock over 8yrs
Source: FE Analytics
Controversies such as Libor manipulation, sanctions breaches in the US and retail conduct failings in relation to bonus schemes for sales staff have meant substantial fines from regulators in the UK and US.
Lloyds set aside nearly £10bn worth of PPI compensation – more than any of the other ‘big four’ completed by Barclays, Royal Bank of Scotland and HSBC. Another shadow was cast last week, after reports that several banks could become embroiled in fresh scandal over the mis-selling of loan insurance.
Currently 25 per cent owned by the taxpayer, Lloyds has not paid out a dividend to shareholders since its financial crisis falls but recent news has suggested it is on the cusp of paying out its dividend for the first time since then.
Steve Davies (pictured), manager of the £123m Jupiter Undervalued Assets fund, is one investor hoping the reports are accurate although he notes that it will only be apparent when Lloyds announces its full-year results on 27 February.
“It would be tiny, not a meaningful amount, but in terms of a signal it would be very significant. However, it is in the hands of the regulator – who are very hard to second guess, but Lloyds will have good case [to take to the regulator] with Barclays and HSBC both paying dividends,” Davies said.
“Margins have expanded as they have benefited from rising mortgage rates while funding costs, particularly deposits, have come down. Further margin expansion may prove hard to come by but banks should see a further boost to their bottom line as UK interest rates start to rise – in our view, by early 2016 at the latest.”
“A further by-product of the resilient UK economy is that loan demand is starting to perk up and should continue to strengthen in the months ahead. Additionally, profitability at UK banks has been enhanced by the implementation of serious cost-cutting measures: Lloyds Bank, for instance, has had its ‘Simplification’ programme in place since 2011, and now expects it to deliver savings of £2bn in 2014.”
“We believe Lloyds is capable of generating as much as 10p a share of profit of which at least 50 per cent could be paid out as a dividend, if not more given the bank’s moderate growth outlook.”
Davies also says that banks may prove increasingly sought after by income-hungry investors and by fund managers in larger cap stocks looking for alternatives to oil majors such Shell and BP, which have come under balance sheet pressure from its near 60 per cent plunge in the oil price shown below.
Performance of stocks and index over 1yr
Source: FE Analytics
However, he says there is a risk in holding a large bank in event of a Miliband-led victory for the Labour party on 7 May, due to the leader of the opposition’s comments on lambasting banks with a large market share.
“Ed Miliband has made no secret of his wish to break up the high street banks – a threat, if carried out, that could have the biggest repercussions for Lloyds and RBS. However, with an official competition inquiry already in progress, the Labour leader’s hand might be somewhat tied by the findings of this inquiry were he to make it into government.”
The manager has the stock as one of his largest positions in his concentrated fund of 37 holdings, making up 7.5 per cent of the portfolio.
It is unlikely to get much bigger, Davies says, although he believes it makes a good longer term holding thanks to its broad base of customer accounts, which he says will be beneficial to the bank as interest rates rise.
Davies is optimistic that apart from Lloyds other UK banks may be in a position to deliver substantial dividend pay outs to shareholders in the next 12 to 18 months as they become more able to generate profits after regulatory requirements on capital and leverage are met.
“It has been a lengthy convalescence, and while there may still be some way to go, the outlook for some of the UK banks worst hit by the financial crisis of 2007-08 now appears much brighter,” he said.
“This is striking at a time when several of them remain lowly valued both by historical standards and in relation to the wider market, making them, in our view, some of the strongest recovery opportunities on the UK stock market.”
Sarah Emly, manager of the JP Morgan Claverhouse Investment Trust, is also bullish on holding UK banks for income over oil stocks.
“As UK equity income investors debate about the medium-term security of dividends from some of the more commodity focused stocks such as the oil majors, despite the assurance of the importance of dividends given by the CEO of Royal Dutch Shell last week, there are other sectors in the UK market that offer investors good dividend growth prospects and/or premium dividend yields,” she said.
“The broad financials sector is one such example,” Emly added, while specifying several places where investors could benefit.
Some of the major UK life insurers, for example Legal & General, are premium dividend yielders, she pointed out, while others like Prudential offer strong dividend growth records.
“Aviva proposed takeover of Friends Life will accelerate and enhance Aviva’s own dividend growth prospects,” she added.
“Mark Wilson, CEO of Aviva, has said that Aviva shareholders will see a 30 per cent increase in the Aviva final dividend for 2014, making a total dividend per share for the year of 18.1p.”
Emly also says other financial services companies offer strong dividend growth prospects, such Jupiter Fund Management, and premium dividend yields, as in the case of Provident Financial.
These financials with attractive dividend yields/dividend growth rates are all held by Claverhouse.
