Since the beginning of 2014, shares in Lloyds (LSE: LLOY) have fallen by 20% as the bank has failed to excite investors. Investor sentiment towards the banking sector has also remained depressed. Combined, these two factors have held the bank back.
However, I believe that three upcoming catalysts could light up the shares over the next year or so, and if these catalysts do emerge, investors should be well rewarded.
Rising interest rates
After the Brexit vote, the Bank of England decided to lower its main lending rate to 0.25%, the lowest level ever recorded. Designed to stimulate growth, this rate reduction has made borrowing more affordable, but while borrowers have benefitted, banks have suffered.
Banks’ profits’ fall when interest rates decline as the interest rate spread — the difference between what they pay to depositors and charge lenders — drops. As well as the tighter spread, higher costs stemming from increased regulation and PPI redress have capped Lloyds’ profits.
To break out, last year the bank acquired credit card provider MBNA, which should help boost the lender’s net interest margin by about 10 basis points a year. It has previously said the margin would be around 2.7% in 2017 but management is now targeting 2.8%. For 2014 the group reported a net interest margin of 2.45%.
Also, during the next few years, PPI claims should start to fall, and the latest noises from the bank of England indicate that the central bank will raise interest rates later this year. All of these factors point to a bright outlook for Lloyds’ shares.
Rising interest rates are just one of the factors that could help drive shares in Lloyds higher. The bank’s dividend is another catalyst.
Lloyds has transformed from a struggling turnaround into one of FTSE 100’s top dividend stocks over the past three years. As earnings grow, and the bank’s capital position continues to improve, dividend payments should only increase going forward.
Indeed, one group of City analysts believe that Lloyds could produce total shareholder returns of 9% in 2017, including an ordinary dividend of 3.5p at a yield of 5.4% as well as a £1.7bn share buyback. These hefty prospective cash returns will make the shares attractive for income investors.
Cash payout and rising profits are all well and good, but if the banking sector continues to remain out of favour with investors, then shares in Lloyds will continue to be depressed.
Nonetheless, I believe that it’s only a matter of time before sentiment towards the industry improves. Economic growth around the world is picking up, the Brexit depression has, as of yet, not materialised and many banks have now nearly fully recovered from the financial crisis.
As Lloyds’ profits benefit from falling PPI claims, higher rates, and the MBNA acquisition, and it pays these higher profits out to investors, sentiment towards the shares should improve dramatically, possibly pushing the price back up to the one-year high of 72.5p
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.