The Risks Of Investing In Lloyds Banking Group PLC

Today I am explaining why I believe Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) could be considered a disappointing stock selection.

Capital questions to arise once more

Like the rest of the British banking sector, Lloyds successfully sailed through the European Banking Authority’s (EBA) minimum capital requirements under adverse conditions last month. Still, the end result could hardly be considered a resounding success.

Lloyds qualified with a CET1 ratio of 6.2%, beating the EBA’s target of 5.5%. But this is not the end of the matter as the company still has to jump through the hoops laid down by the Bank of England next week, a situation that promises to underline the institution’s frail cash pile once again.

This latest examination assumes a far steeper 35% decline in the housing market, as well as a rise in interest rates to 6%, scenarios that will undoubtedly put Lloyds’ balance sheet under severe scrutiny. The bank is comfortably the UK’s biggest mortgage provider and provides a quarter of all new home loans, so expectations of a favourable decision is by no means a given.

Unlike the Co-operative Bank, which has said that a failure next week would come as “no surprise,” Lloyds remains bullish that it will hurdle The Old Lady of Threadneedle Street’s more challenging tests. Still, should fresh question marks emerge over the bank’s financial health, current City forecasts for dividends to restart in the coming months could receive a hammer blow.

Legal costs continue to soar

Lloyds is not alone in falling foul of banking regulators across the globe, and like the rest of the sector faces the prospect of a continued stream of legal bills stretching long into the future.

The business was forced to hike provisions for the mis-selling of payment protection insurance alone by £900m during the third quarter, taking the total to some £11.3bn. Lloyds is also under pressure as the number of claims associated with the wrongful sale of interest rate hedging products in recent years continues to tick higher, too.

In other news, the Black Horse is facing legal action from a band of shareholders alleging that the bank provided misleading information about the health of HBOS prior to its takeover by Lloyds back in 2008. The claimants are seeking a further £400m in damages.

Lloyds cannot avoid the media spotlight over previous misconduct for love nor money, a situation which looks likely to drag on and on and create a steadily-worsening dent in its pocket.

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Royston Wild 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.