Why Lloyds Banking Group PLC Should Yield Over 7%

Before the financial crisis hit, Lloyds  (LSE: LLOY) (NYSE: LYG.US) was one of the UK’s biggest dividend payers. The bank paid out just over half of its profits during 2005 and 2006, which equated to a dividend yield of between 6.5% and 7% during each year respectively.

Unfortunately, Lloyds lost its dividend crown as a result of the financial crisis, but now the bank is returning to health these hefty payouts are set to resume.  

Pleasing regulatorsLloyds

However, before Lloyds can begin to issue dividends again, the bank first has to seek the approval of the banking regulator, the Prudential Regulation Authority (PRA), which is part of the Bank of England.

It is likely that the PRA will want to ‘stress test’ the bank, to ensure that it can support the payout and is not digging into its capital reserves. 

Indeed, it is believed that regulators will need Lloyds to show that it has a tier one capital ratio of 11%, or more, before they allow a dividend to be paid. Luckily, at the end of the first quarter, Lloyds revealed that it had a tier one capital ratio of 10.7%; just under the likely required minimum.  

What’s more, Lloyds’ profit hit £1.8bn during the first quarter of this year and costs fell 5%, so the bank’s capital position is rapidly improving. Furthermore, Lloyds is benefitting from the UK economic recovery and the bank’s net interest margin should rise by around 5%, to 2.4% this year. 

As its capital position improves and profits surge, Lloyds believes that the regulator will grant it permission to pay a dividend during the second half of this year. 

Chucking out cash 

If Lloyds’ does get the go ahead from regulators to restart dividend payments, City experts believe that the bank will return around 70% of income to investors. This implies that current dividend forecasts are actually to0 low!

For example, City analysts are currently predicting that Lloyds will support a dividend yield of 1.9% this year, followed by a yield of 4.2% during 2015. However, these payouts will only be around 50% of earnings. 

If City predictions prove true and the bank does hike its payout ratio to 70%, then with earnings of 8p per share forecast for 2015, Lloyds’ could offer a dividend payout of 5.6p per share, a yield of around 7.1%.

Should you buy in?

Only you can decided if Lloyds fits in your portfolio and I'd strongly suggest you look a little closer at the company before making any trading decision. 

However, placing a valuation on banks is never a simple task, and to help you conduct your own analysis, our analysts here at the Motley Fool have put together this free report entitled, "The Motley Fool's Guide To Banking".

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Rupert does not own any share mentioned within this article.