FTSE 100 stock Lloyds Banking Group (LSE: LLOY) has been a favourite with income investors for a long time, and it’s easy to see why. The UK’s largest retail bank currently boasts a dividend yield of over 5% and follows a centuries-old model: loan money out at a higher interest rate than you pay on your deposits. Although this conservative strategy limits the possibility of a sharp appreciation in share price, it does provide investors with some assurance that their dividend payouts will continue.
Decent results and a resilient model
Although its most recent earnings report was viewed as a bit of a disappointment, the bigger picture still looks good for Lloyds. Even though the banking sector as a whole has been depressed, Lloyds has proved to be more resilient than most. The bank’s net interest margin (the difference between interest charged to lenders and interest paid out to depositors) has remained stable at 2.9%, falling just 0.01% compared to the previous period.
Furthermore, the Prudential Regulation Authority recently decided that Lloyds was safe enough to allow it to decrease its risk buffer, unlocking a potential £1 billion, which can now be distributed to shareholders in the form of share buybacks or dividend increases.
Not everything is smooth sailing
However, it would be remiss to not cover some of the risks facing the bank at this point. The fallout from Payment Protection Insurance mis-selling continues to weigh on large retail banks like Lloyds. Earlier this month, the bank announced that it was setting aside a further £100 million to cover compensation costs. I do think that this is a problem that will eventually go away, but it does continue to be a thorn in their side.
A bigger issue for Lloyds would be a slowdown in the housing market, given how reliant it is on mortgage lending. The latest data shows that the number of first-time buyers is down 2.4% over the last 12 months, and if that situation gets worse, retail banks like Lloyds would be adversely affected.
Potential Brexit upside
It seems odd to talk about Brexit as something that may be good for stocks, but in this case I think it’s warranted. At this point, the uncertainty surrounding the process is a bigger drag on UK financials than an orderly Brexit (which has largely been priced in) would be, and at this point I think that Lloyds would respond positively to most resolutions to the impasse.
Of course, there still remains the possibility of a no-deal scenario, which could have damaging long-term effects on the entirety of the financial sector. However, I still think that Lloyds is comparatively better positioned than some of the challenger banks that have been nipping at its heels over the last few years. If anything, a no-deal scenario could exert enough pressure on the banking industry to make it consolidate, and in that case you should expect to see bigger lenders like Lloyds doing better.
Stepan has no position in any company mentioned in this article. 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.