Problems At Lloyds Banking Group PLC Could Threaten Dividend Restart

LloydsShares of Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) have fallen by more than 4% so far this week, as investors react to concerns that the bank’s recovery may not be strong enough to allow Lloyds to resume dividend payments this year.

What’s the problem?

Lloyds shares fell yesterday after European banking stress tests revealed that it was the poorest performer of all the main UK banks, scraping through the tests with a capital ratio of just 6.2%, less than 1% above the 5.5% minimum required by European Banking Authority.

There may be worse to come, too: the Bank of England is conducting its own stress tests later this year, which require UK banks to be able to show they could cope with 12% unemployment and a 35% peak-to-trough fall in house prices. This could be tough for Lloyds, which is the UK’s largest mortgage lender.

There’s more bad news

Lloyds shocked investors this morning with news that it has allocated an additional £900m to PPI compensation payouts.

Lloyds has now allocated more than £11bn to PPI, and today’s news suggests the scandal could end up costing more than expected.

What about good news?

Lloyds’ third-quarter earnings were fairly decent: net interest income rose by 11%, underlying profit was up by 35%, and the bank’s net interest margin — a key measure of profitability — rose to 2.44% during the first nine months of this year, up from 2.06% for the same period last year.

Lloyds has also unveiled a strategy update, which appears to be built around slashing costs by closing 200 branches and laying off 9,000 staff, while enhancing the bank’s online services.

The bank is targeting cost-savings of £1bn per year by the end of 2017, and a cost: income ratio at that time of around 45%. This would be impressive — Lloyds’ current ratio of 50% is already lower than most competitors — and might be good news for shareholders, if underlying growth is maintained.

Is the dividend safe?

Lloyds says it is still in discussions with the Prudential Regulation Authority about resuming dividends, but this decision will almost certainly be postponed until after the results of the Bank of England stress test are known — and could be a PR disaster if it coincides with the start of large-scale redundancies.

Overall, I suspect Lloyds is unlikely to declare a dividend this year, and believe there are more appealing options elsewhere in the banking sector.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.