Why I’m not a buyer of Lloyds Banking Group plc after recent declines

Before the financial crisis, Lloyds (LSE: LLOY) was a cash cow. The bank’s simple business model helped it capitalise on the UK’s booming economy. Cash reserves swelled and the bank couldn’t return enough cash to shareholders. Unfortunately, Lloyds’ beneficial position drove the bank’s management to acquire HBOS during September 2008. Management was eager to grow the business and HBOS seemed to be, at the time, low-hanging fruit.

The problems HBOS and Lloyds had following the merger are well documented as Lloyds paid the price for reckless lending at HBOS over the years.

However, after several years of turmoil it’s nearly back to its former self. The bank’s capital position is robust, return on equity is in the mid-teens and the group has plans to pay out a substantial dividend to investors going forward. Specifically, at the end of the first half, the bank reported a common equity Tier 1 ratio of 13%, a tangible net asset value per share of 55p and a return on required equity of 14%. Total income was reported at £8.9bn. Alongside these results management declared an interim ordinary dividend of 0.85p per share, up 13% up year-on-year.

Not attractive

Despite these positive operating metrics, I’m not attracted to Lloyds. You see, it would appear that the bank is now suffering from the same problem that it did nearly 10 years ago. The group is generating plenty of cash, but growth is proving elusive. Competition in the UK’s banking sector is increasing and low interest rates are squeezing Lloyds’ net interest margin. That’s the difference between what the bank pays its depositors in interest and what it receives in interest on loans.

After several years of steady earnings growth and revenue recovery, City analysts are now cautious about the outlook for the bank’s earnings for the next few years. Indeed, analysts have pencilled-in an earnings decline of 14% for the year ending 31 December 2016 and a further decline of 13% for the year after. The current figures suggest the bank is set to report earnings per share of 6.4p for 2017, around one-third less than the figure of 8.5p reported for 2015. Hopefully, Lloyds has learnt its lesson and won’t go chasing growth at any price this time round as it did with HBOS in 2008.

But despite stagnating earnings, the City expects Lloyds’ dividend payout per share to grow during the next two years a dividend of 3.4p per share is predicted for 2017. At current prices this would equate to a yield of 5.7%.

The bottom line

So, while Lloyds has returned to its roots as a champion income investment, the bank is struggling to grow and for this reason, I’m not interested. Banking is an unpredictable industry and for dividends, I would rather look to the typical FTSE 100 dividend stalwarts such as GlaxoSmithKline and Royal Dutch Shell.

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Rupert Hargreaves owns shares of GlaxoSmithKline and Royal Dutch Shell B. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.