73.6p may seem an odd target for a stock to hit, but for the UK government this is the price at which it breaks even on the 9% stake it retains in Lloyds (LSE: LLOY) after the 2008 bailout. With shares currently languishing at 54p and economists expecting a sharp economic downturn in the coming months, will the UK remain Lloyds’ largest shareholder for the foreseeable future?
Signs are pointing towards yes in my opinion.
First off, despite shares nearly reaching the 73.6p mark prior to the referendum, all was not well at the banking giant.
The largest issue for Lloyds was the gaping hole on its balance sheet that has been the £16bn set aside for PPI claims since 2011. This problem isn’t over yet as the FCA decided last month to extend the claims deadline yet again, which is likely to prompt another surge in payouts.
Furthermore, despite progress in cutting branches and jobs the company’s cost-to-income ratio remains high at 47.8%. This is better than at competitors but with revenue falling 1% in the past half year alone the company can only rely on job cuts for so long to maintain the bottom line.
Then came Brexit…
While the full impact of the expected economic downturn will only be seen in the coming months and years, we’ve already had a taste of the bitter medicine Brexit will force banks to swallow.
This medicine came in the form of Mark Carney slashing base interest rates by 25 basis points down to 0.25%. This is a critical cut for all banks as it will invariably lower net interest margin, where the bulk of their profits come from. All major lenders except for Lloyds fairly quickly announced a cut to the interest rates they charge many borrowers, but the black horse wasn’t far behind with its own announcement on Monday.
Of course, the reason the BoE slashed interest rates to their lowest level in history should be the biggest worry for Lloyds shareholders. As the UK’s largest retail bank, and with no foreign operations to draw upon, any contraction in the domestic economy will hit the bank hard.
Last month’s fall in the closely-watched GfK consumer confidence index was its worst since 1990 and is a major warning sign for Lloyds that consumers plan to put off making major purchases. As the UK’s largest mortgage provider, this should be a major indicator for Lloyds that the coming quarters could be rough.
So, if growth isn’t likely due to what could be a sharp recession, can investors at least rely on high dividends to cushion the blow?
There’s bad news on that front as the company blamed Brexit for lowering guidance on annual capital generation during last month’s interim results presentation. That sent many analysts scrambling to lower their forecast dividend payouts in the coming quarters.
With profits already forecast to contract over the next two years, Brexit casting a pall over the domestic economy and dividends unlikely to rocket anytime soon, I don’t see Lloyds’ shares jumping 36% to reach 73.6p any time soon.
