Considering that UK Financial Investments had previously stated its intention to dispose of the full stake within the first half of 2015, the government probably didn’t surprise very many people on Friday when it announced that it had finally sold another substantial portion of Lloyds Banking Group (LSE: LLOY), reducing the remaining balance of its holding to 11.98%.
The decision certainly never took the market by surprise as the shares were up 2.18% by mid afternoon in what was generally a good day for British banks and the broader blue-chip indices.
Lloyds has long been a company that I’ve held mixed feelings about and, as a result of Friday’s news, now seems a good time to review some of the pros and cons that come with ownership of the shares.
The upsides of ownership
Lloyds has come a long way since the dark days of the financial crisis. Today it is a slimmer and much more focused business that, after returning to profitability in 2014, has re-emerged on the radars of investors as both an income and a growth play.
Much of the good news on the earnings front has been the result of consistent improvements in the condition of the bank’s loan book (lower impairments), in addition to management’s work to reduce costs and to gradually address its regulatory liabilities for past conduct issues.
The result of this work was an interim dividend of 0.75 pence per share for the first half of 2015, which could soon be followed by a larger final dividend.
There is also some scope for earnings to improve from their current base in the coming years, if the economy continues to improve and higher interest rates do not disturb the reduction in loan impairments that has been one of the core drivers of an improving financial position during recent years.
The downsides to ownership
Provisions for past conduct are still a major issue for Lloyds, something which was evidenced by a further £1.4 billion cash charge to the income statement for the first half of 2015.
While one would think that after so much time such costs would now be beginning to reduce, claims activity is still volatile according to management… which means that further charges cannot be ruled out in future periods.
While the group reported underlying earnings per share of 4.1 pence for H1, the it lost 30% of this as a result of the aforementioned charges.
It also took further non cash charges for impairments, depreciation, and losses on disposal of assets which, which ultimately reduced its true earnings per share (International Financial Reporting Standard Eligible EPS) to just 1p for the period.
If such costs are to be repeated in future periods, then it is possible that Lloyds shareholders expectations for dividend growth may begin to look slightly ambitious.
Furthermore, higher taxes could also threaten growth at Lloyds, given the Chancellor’s 2015 decision to replace part of the bank levy with an additional 8% profits tax. This will now push Lloyds effective tax rate up from 22.5% to around 30% of profits, according to the group CFO.
This also places a question mark over the likely pace of earnings and dividend growth at Lloyds during the near- to medium-term.
Summing Up
With concerns over the potential impact of higher taxes and further regulatory provisions set aside, I am slightly sceptical of the group’s ability to meaningfully grow earnings in an environment where the market for retail banking services is becoming ever more crowded with new “local banking” focused entrants.
After considering these things, in addition to the possibility that the rate of decline in loan impairments could begin to dissipate once interest rates rise, I find myself growing wary of whether or not the group will be able to meet the ever more elevated expectations of investors during the quarters ahead.
It is for this reason that I will probably continue to walk on by when it comes to Lloyds shares, although I admit I will wait keenly to see if this behaviour proves overly cautious of me or if my concerns have been justified.
