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Why You Should — And Shouldn’t — Invest In Lloyds Banking Group PLC

Today I am analysing the investment case for Lloyds Banking Group PLC (LSE: LLOY) (NYSE: LYG.US).

Payouts predicted to march forth

Although Lloyds is still awaiting approval from the Prudential Regulatory Authority (PRA) to resume its dividend policy, the City’s army of analysts seem convinced that the bank will receive the thumbs up in the coming weeks. And once the box is finally ticked, Lloyds is anticipated to hit the ground running.

For 2014 the bank is expected to fork out a token final dividend of around 1p per share, and for 2015 total payouts are expected to clock in at 2.8p. As a result Lloyds offers up a tasty yield of 3.8%. And expectations of sustained earnings growth through to the close of 2016 pushes the forecast to 4.3p for next year, which would create a tremendous 5.8% yield.

Balance sheet bother undermines projections

However, I believe that the condition of Lloyds’ capital pile could have a sobering effect on the board’s enthusiasm to deliver rip-roaring dividends in the near-term, not to mention the PRA’s view on restarting shareholder payments.

The firm scraped past the European Banking Authority’s minimum CET1 capital threshold of 5.5% in October, passing the test with a reading of 6.2%. And although Lloyds also passed the Bank of England’s December exams, the central bank advised that the company remains susceptible to a severe economic downturn.” Consequently the bank could face a hard time when next year’s even tougher assessments come into view.

Capital pile faces continued stress

Lloyds’ head honcho António Horta-Osório is quick to point out that the firm has undertaken much heavy lifting since the end of 2013 to build its capital buffers. And while this is undoubtedly true, the effect of various legacy issues is likely to undo much of this hard work as cash keeps seeping out of the bank.

Indeed, there seems to be no end in sight to the steady stream of claims relating to the mis-selling of PPI and interest rate hedging products in previous years, problems for which Lloyds was forced to stash away an extra £900m during July-September.

On top of this, the firm also faces the consequences of the tax crackdown laid out in Chancellor Osborne’s Autumn Statement, a move which halves the amount of taxable profits which can be carried forward by Britain’s banks. This will result in a £2.5bn one-off hit to Lloyds’ balance sheet.

Earnings prospects on the up?

Still, Lloyds’ success in riding the British economic revival will go some way to assuaging concerns over the company’s near-term earnings and dividend prospects. The business saw income rise 3% during the first nine months of 2014, to £13.9bn, a result which helped push underlying profit 35% higher to just under £6bn.

And with Lloyds’ Simplification transformation strategy still ticking along nicely — the company announced the closure of a further 200 branches in October — it could be argued that the future is finally looking rosy following the humiliations of the 2008/2009 banking crisis.

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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.