Ken Odeluga: Lloyds Banking Group—the year of the dividend

<p>The UK’s financial services sectors, notably banking, were a further standout sector on the weaker side of the ledger as lenders remained beset by a […]</p>

The UK’s financial services sectors, notably banking, were a further standout sector on the weaker side of the ledger as lenders remained beset by a host of regulatory and structural problems.

The chickens coming home to roost on a range of legal fronts, concerning Libor, foreign exchange trading, the mis-selling of payment protection insurance to consumers and of derivatives to businesses, cashpoint software failures and others, helped to slice more than 10% off the Banking sector in 2014.

To the risk that legal settlements will balloon further in 2015, we can add the likelihood of further capital raisings that diluted the likes of Barclays Plc. shareholders over the last two years.

In October last year, the higher end of analyst consensus forecasts for Barclays Plc. saw £2.4bn net income for the full year ending in December 2014; £3.8bn in 2015; £5.1bn in 2016; and £5.8bn in 2017.

Whilst these expectations suggest investors expect the bank to revert back toward its five-year average net income, they do follow the total net income of just £540m that the group reported in 2013.

So, one would have to believe Barclays’ net income will surge by 974% from the level reported at the end of 2013 to an expected £5.8bn in 2017.

In short, expectations for the UK’s largest bank look like they could do with some adjustment.

HSBC Plc. faces an expensive year as it makes provisions for increased ring-fencing costs; although its regulatory capital ratios came out as amongst the highest against its peers in the US, Europe and following the Bank of England’s ‘stress-test’ exercise at the end of last year.

HSBC missed third-quarter earnings expectations last year after setting aside $1.6bn-plus for the cost of legal settlements and customer compensation. Costs facing the bank are only set to increase over the next few months, setting a potential ceiling on profit growth.

On a valuation basis, forward price-to-earnings ratio of 10 times will draw buyers, especially in the event of market or sector downturns that are likely to be seen in 2015. But, for growth, HSBC wouldn’t be my choice this year.

Royal Bank of Scotland Plc. also continues to face regulatory and impairment-related costs in the New Year, setting aside a further £801m in impairment provisions in its third quarter: with a separate £780m to cover litigation and internal conduct issues.

RBS was also busy slimming down in 2014, including many profitable outfits, like Direct Line Insurance. It will also conduct an IPO of Citizen’s Bank this year, likely to come somewhere between $3.01bn and £3.46bn.

It looks like RBS’s core profitability and earnings growth are set to improve further over the next few years, but are the shares good value now?

On the basis of growth and cash, RBS would therefore be a close rival against Lloyds Banking Group Plc, which will inevitably be prone to the same factors as the other behemoths mentioned above.

But the average UK and Ireland bank stock yield seems to be around 2.1%, rising with the riskier choices, like Standard Chartered, but RBS’s forward P/E is 11.5 and rising in the years further out; whilst forecasts suggest Lloyds can be bought at an expected multiple of 9x currently, for the next twelve months.

On the negative side, the Prudential Regulatory Authority/Financial Conduct Authority will soon start reviews of UK banks’ internal models for calculating regulatory risk-weighted assets.

Lloyds had the lowest RWA/Total Assets ratio of the main UK banks yet a premium valuation in terms of price/tangible book. This is a clear valuation (and in turn share price) risk, if regulatory scrutiny concludes that Lloyds’ internal risk assessment was too easy on itself.

Not forgetting of course, the steady drip of the UK government’s 24.9% stake sell-down.

The HM Treasury’s broker, Morgan Stanley, has discretion to sell up 15% of aggregate total trading volume against an average volume of 121m shares traded on the market each day, and the government’s stake which equates of 17.8bn shares. It could take more than six months.

In terms of a long-term value play, this overhang can be viewed as a low-hanging opportunity.

2015 is the year it would be most logical (unforeseen shocks aside, for which Lloyds was an effective magnet last year) for authority to pay dividends to be granted by the PRA.

A penny is seen as the most sensible guess for the 2014 dividend, though market consensus seems to veer towards 1.25p. And that rises to around 3p for the full dividend in 2015.

If you found this article useful, you might also want to read Ken’s article on the FTSE at risk of significant correction as global equities weaken.

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