Is It Time To Bite The Bullet And Buy Barclays Plc & Lloyds Banking Group Plc?

While competitors continue to muddle along with half-hearted restructuring efforts, Lloyds (LSE: LLOY) saw the writing on the wall early and has nearly finished transforming itself into a healthy, domestic retail bank. With substantial dividends finally returning, is now the time to buy into the turnaround at Lloyds?

Bye bye PPI

The story for Lloyds over the past few years has been the staggering £16bn it has paid out for PPI claims. Thankfully, with claims predicted to wind down some time in 2018, the £4bn set aside last year is likely to be Lloyds’ last PPI-related payment.

This isn’t the only good news for Lloyds’ balance sheet. The bank’s common equity tier 1 (CET1) level has remained stable at 12.8%, meaning its capital buffers are sufficient to meet regulatory requirements. With no more cash needing to be funnelled to PPI claims or capital buffers, shareholders will begin to see increasingly large returns through dividends.

In fact, Lloyds’ balance sheet was in rude enough health at the end of 2015 that the company announced a special 0.5p per share dividend. This brought total dividend payments for the year to 2.25p per share, or a roughly 3.1% yield. Analysts are expecting this dividend to grow further to 4.12p for 2016.

Even as these dividends begin increasing substantially, the shares aren’t horribly overpriced. They currently trade at 1.11 times the company’s book value and 9.6 times forward earnings. At these levels, the shares don’t leave room for considerable growth. However, that’s okay since Lloyds will be more of an income share going forward. And with a strong underlying business, stable outlook for the domestic economy and possible end to PPI claims, I see significant dividend growth ahead for Lloyds.

The investment bank issue

As Lloyds investors enjoy higher-than-expected dividends, shareholders of Barclays (LSE: BARC) have seen their dividends for the next two years cut in half. Barclays’ relatively low capital levels, with CET1 at just 11.4%, show why this move was necessary as the bank sets forth on yet another restructuring plan.

New CEO Jes Staley, the bank’s third chief in the past five years, is rightly cutting non-core assets and reorienting the bank towards its traditional transatlantic breadbasket. This will involve selling-off its sprawling African assets, which could take several years, but will shore up the bank’s CET1 ratio by around 100 basis points.

Why Staley is insisting on keeping the underperforming investment bank, however, is an open question. The IB division’s RoE is a meagre 5.6%, while Barclaycard, the credit card arm, runs an RoE of 17.7% and UK retail banking’s is 12.1%. Meanwhile, the IB division eats up 30% of the group’s risk-weighted assets and is barely worth the cost of capital.

Although decrying activist investors’ zeal for breaking up companies is oftentimes correct, in this case I see a clear reason for doing so. And until Barclays comes to this same conclusion, I’ll be steering well clear of its shares. The bank’s low-risk credit card and retail divisions are incredibly strong, but I believe the outsized IB will be a drag on profits for years to come.

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