The motivation for buying shares in Lloyds Bank (LON: LLOY) is simple: income.
Before Covid, the giant seemed to be returning
Before Covid, Lloyds seemed to have at last exorcised the twin ghosts of the 2008 crash and PPI payments. It had begun paying dividends again in 2015, peaking at 3.21p in its financial year to the end of 2018. To put that dividend in perspective, it would amount to a dividend yield of around seven per cent at the current share price. Things were looking encouraging in 2019, with the Lloyds interim dividend at its highest level since 2008. The final dividend was due to be paid in April 2020, but Bank of England fears over the possible economic cost of Covid forced Lloyds to hold its dividend payment.
Consider the Lloyds outlook before Covid. It bought MBNA in 2016 for £1.9 billion in 2016; consequently, its share of the UK credit card market increased to around a quarter. Moreover, the bank secured significant cost savings in the process.
Then in 2018, Lloyds and Schroders announced a new joint venture in which Lloyds took a 50.1 per cent stake and a hefty stake in the holding company of Schroders’ UK wealth management business.
Covid and Lloyds
With the Covid crisis, Lloyds shares plummeted, falling from 63p in December 2019 to less than 30p by the spring of 2020. They were uncertain times; the economic mood was bleak, no one could have even taken a sensible guess at the potential economic cost of the pandemic.
In 2021, the world seems quite different, and the economic prospects have been transformed. Many economists now believe the UK economy will be stronger by the middle of this decade than the pre-Covid projected forecast. The combination of an accelerated shift towards digital, a change in mindset favouring remote working and massive monetary and fiscal stimulus from the Bank of England and UK government respectively, could well see the UK economy enjoy its strongest performance for many years.
The new outlook for Lloyds and its share price
For a bank which is so dependent on the UK economy, conditions look good, but with one qualification, which I will come to shortly.
Not only do the economic prospects suit Lloyds, but its rumoured planned purchase of retirement savings and platform company Embark Group could give the bank a bigger foothold in wealth management.
Its incoming CEO, Charlie Nunn, could herald a new era for the bank. Its outgoing CEO, António Horta-Osório, successfully steered the bank through its difficult years; Nunn could be the man to lead amid a more favourable climate, with a greater emphasis on wealth management.
Remember also, Lloyds was given a raw deal during the 2008 crisis. The UK government forced its hand in buying HBOS, and it was this merger that so damaged the bank’s balance sheet leading to the necessity of a government bailout. So to those who say Lloyds expansion plans bring about a sense of deja vu, a rekindling of pre-2008 recklessness, I would say remember Lloyds’s biggest mistake was buying HBOS but was given little choice by authorities.
There is one nagging doubt: suppose inflation becomes a major threat to the UK economy, and the Bank of England is forced to increase interest rates significantly. Higher interest rates will be good for Lloyds’ margins but may lead to a crash in house prices, which would hurt the Lloyds mortgage business.
I would say that on balance, dividends are likely to significantly surpass the 2018 level within a few years, at the current share price that could represent a forward dividend yield approaching 10 per cent, and that prospect is enticing indeed.