A few years ago, the prospects for the banks, and Lloyds in particular, looked weak. They were still limping forward after the 2008 baking crash, and they faced another problem. First, there was the threat posed by challenger banks. Some saw the writing on the wall for traditional banks and for more than one reason.
Firstly, there was the Open Banking regulation called PSD2. The regulation handed rival challenger banks a massive advantage, making the process for customers wishing to change banks much easier.
Secondly, there was the IT legacy holding the big banks, such as Lloyds, back whilst challenger banks with their newer IT systems could react rapidly to customer needs.
Thirdly was the damage done to banks’ reputation, caused by their behaviour leading up to the 2008 crash. There was a growing feeling that big tech companies would grab banks’ market share, with Lloyds Bank a particular casualty.
And fourthly, there were new digital technologies such as peer to peer lending, crowdsourced funding, and blockchain, which threatened to undermine the entire edifice of the banking money machine.
But things now seem different, and here are five reasons to expect better days from banks and their dividends, including the Lloyds dividend.
Reason one: the challenger banks challenge wilts
True, the challenger banks, the likes of Monzo and Revolut, have gained customers; but they have found it harder to turn a profit. For example, Monzo made a big loss in its latest quarter, whilst Revolut saw losses double in 2020.
The IT legacy problem is not as severe as it once was; the bad boy image is largely forgotten, and public anger seems to have flipped; it is now geared towards the big techs. And peer to peer lending and crowdsourced funding doesn’t seem to have made any dent in bank’s profits. As for cryptocurrencies posing a threat to banks — maybe they will, one day, but with the Bitcoin price still a third down from the year high, there is little evidence to suggest blockchain will impact bank’s business for the foreseeable future.
So that’s one reason to be optimistic about Lloyds, which will impact their dividends — the predictions of doom from six years ago have not been realised.
Reason number two: the recent return of dividends
The banking dividend bonanza is already beginning. Lloyds has recently announced an interim dividend after its net income in its first half surged eight per cent from the second half of last year.
Analysts and balance sheet strength
The Lloyds balance sheet is impressive. But, more to the point, the group’s core equity tier 1 ratio is 16.7 per cent. The equity tier 1 ratio is a bank’s equity capital and disclosed reserve relative to its total risk-weighted assets. Contrast that ratio with the level required under the Basel III regulation of 10.5 per cent.
Furthermore, the Bank of England recently removed its “extraordinary guardrails,” which it imposed on banks during the Covid crisis.
The combination of surging profits, strong capital ratios and the relaxing of banking guardrails by the Bank of England recently moved the broker Jefferies to predict that Lloyds, along with Barclays, could “repatriate” approximately 30 per cent of their market capitalisation over the next two or three years — to the end of 2023.
Baby boomers retiring
The fourth reason is something of a self-fulfilling prophecy. Lloyds’ dividends are likely to rise because investors demand it. One of the most important economic developments of this decade will be the retirement of the baby boomers. The need for high dividend-paying stocks has never been greater, and Lloyds is likely to oblige.
The economy could be heading towards something of a sweet spot for Lloyds and its dividend. Banks all benefit from higher interest rates but are not likely to do well in times of very high inflation. So, the recent inflation scare has been cause for concern. But recent data out of the US brought good news, with the month on month US inflation rate falling from 0.9 per cent in June to 0.5 per cent in July. Other indications are encouraging, too, with the lumber price, for example, losing two-thirds of its price since May. So, the chances of excess inflation seem to be diminishing.
Nonetheless, there are many signs of strong economic recovery in the making. For example, the latest Purchasing Managers Index tracking UK services pointed to five successive months of increasing business activity. The Bank of England does not need to worry unduly about inflation but may reasonably conclude that modest increases in interest rates are in order due to the strong recovery. For banks such as Lloyds, this is good news. Modestly higher rates are likely to improve margins, but a highly damaging return to significant inflation is looking less likely.
The Lloyds dividend is back, but in the next, two to three years is likely to be generous indeed; for investors seeking a dividend yield, rarely have we seen greater opportunities for Lloyds investors.