At the end of last week, UK bank shares slipped following a warning from analysts at Morgan Stanley that Barclays could be forced to sacrifice dividend growth to boost capital. These concerns weighed on Lloyds (LSE: LLOY) shares, which have fallen 8% over the past month to their lowest level in two years.
However, there are several key differences between Lloyds’ and Barclays’ dividends. On one hand, Lloyds already has a robust capital based, which is steadily increasing. The bank’s most recent set of results showed a Tier one equity capital ratio of just under 14%, compared to the regulatory minimum of 12%. The bank’s capital ratio has grown by 1% since the end of 2014.
On the other hand, Barclays’ Tier one ratio is still below 12% of risk-weighted assets. Management is targeting the 12% threshold in the near term, but there are now concerns that regulators could increase the minimum level of capital Barclays has to hold to 13.5%, which would really weigh on cash flows.
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What’s more, Lloyds’ dividend payout is currently covered three-and-a-half times by earnings per share, leaving plenty of room for growth and for the bank to retain some profit to strengthen its balance sheet if needs be. Based on current forecasts, next year Barclays’ dividend will be covered three times by earnings per share, which is hardly concerning but considering the bank’s capital position, management might want to reduce the payout to boost cash balances.
Safe for the time being
Overall, it looks as if Lloyds’ dividend payout is safe for the time being. The bank’s management has adopted an extremely prudent dividend strategy and, by starting from a low base, the payout has plenty of room to grow.
City analysts expect Lloyds to return a huge chunk of capital to investors before the end of the decade as the bank exits its recovery period. With a robust balance sheet and earnings stability, Lloyds has the potential to return £20bn to £25bn to shareholders over the next three years — according to City analysts.
Whether or not the bank actually meets these forecasts is another matter. However, the figures do seem to suggest that Lloyds is going to have a lot of excess capital lying around over the next few years. How management will decide to distribute this capital is not yet known.
Long-term investment
So overall, for the long-term investor, after recent declines it could be an excellent time to buy Lloyds’ shares. Indeed, the bank is well capitalised, is highly profitable and could return billions to investors during the next few years.
City analysts expect the bank to report a pre-tax profit of £8.1bn for full-year 2015 and a pre-tax profit of £8bn for full-year 2016. The bank’s shares currently trade at a forward P/E of 8.6 and support a dividend yield of 3.4%.
However, as profits are expected to fall by 6% next year, Lloyds is trading at a 2016 P/E of 9.3. Still, City analysts are assuming a 50% increase in Lloyds’ dividend payout to investors next year. With this being the case Lloyds’ shares are on track to support a dividend yield of 5.3% next year.
