MENU

3 Reasons Why Lloyds Banking Group PLC’s Dividend Could Disappoint

One of the first promises António Horta-Osório made when he took over as chief executive of Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) in 2011 was to restart dividend payments as soon as the bank was strong enough.

We’d all love to see Lloyds thriving and paying a great income to its shareholders, but I can see three ways in which the Black Horse’s dividend could disappoint.

Dividend resumption

Lloyds hasn’t paid a dividend since 2008 when it ceased payouts as a condition of the government bailout. There were hopes the bank would pay a first dividend this time last year, but a further £2bn of mis-selling costs in Q4 2013 put the kibosh on that. Lloyds’ board said it intended to apply to the Prudential Regulation Authority (PRA) in the second half of 2014 to restart dividend payments, “commencing at a modest level”.

Expectations have been growing that Lloyds will announce a first dividend when it releases its annual results tomorrow. Analysts expect the bank’s capital strength to have improved markedly, with a core tier one ratio forecast at 12.1%, compared with 10.3% last year. Forecast profit of £1.9bn would comfortably cover a symbolic 1p a share dividend costing £0.7bn.

Still, there has been no confirmation from Lloyds and the PRA that dividends can be resumed, so there remains a possibility — albeit a seemingly slim one — that the PRA could spoil the party.

Payout ratio

Back in 2013, the Financial Times claimed that Horta-Osório had told institutional investors that he expected to be paying out 60-70% of earnings by about 2015. It has never been officially confirmed that Horta-Osório — who at the time was wooing investors ahead of the government starting to sell down its stake in the bank — formally articulated such a payout ratio. Nevertheless, a 60-70% or 65% ratio has been taken as read by some financial commentators and private investors on discussion boards.

As things currently stand, Lloyds’ official dividend policy is “to deliver a medium term payout ratio of at least 50%”. If Lloyds simply restates that policy within its results tomorrow, investors expecting an increased payout ratio target of anything up to 70% will be disappointed.

Earnings growth

Whatever the payout ratio, the rate of growth of the dividend will depend on the growth of Lloyds’ earnings. There are a number of things that could peg growth back. Increasing regulatory and compliance costs, fines levied for misdeeds more on the bank’s ability to pay than on the seriousness of the misbehaviour itself, and the political determination for “challenger banks” to compete with the big players.

We’ve already seen some indications this week, from the two big banks that have so far reported results — HSBC and Royal Bank of Scotland — that the future may be more challenging than they’d previously anticipated. HSBC revised its target for return on equity (ROE) to “more than 10%”, saying it previous target of 12-15% is “no longer realistic”. RBS today reiterated its “long-term” ROE target of 12%+, but quietly dropped its medium-term target of 9-11% altogether.

If Lloyds also signals tougher times ahead than previously anticipated, dividend growth may be lower than currently expected.

Assessing the prospects for a company's dividend isn't always easy, but the Motley Fool's top analysts have written a must-read FREE guide: "How To Create Dividends For Life".

This exclusive report shows how dividends can provide the foundations for more dependable returns, and explains 5 Golden Rules for Building a Dividend Portfolio.

This free wealth report comes with no obligation -- simply click here for your copy.

G A Chester 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.