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I’d buy Lloyds shares for the bank’s dividend in 2021

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Before the coronavirus pandemic, Lloyds (LSE: LLOY) shares offered one of the best dividend yields in the FTSE 100. Unfortunately, that stopped at the beginning of last year. Fearing a potential financial crisis, City regulators banned the lender and its peers from distributing any cash to investors. 

Luckily, a financial crisis never emerged. And, towards the end of last year, regulators lifted the dividend ban. With this restriction removed, I believe the bank will reinstate its dividend this year, and I reckon it’s highly likely investors will see substantial cash returns from the lender the near term. 

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Buying Lloyds shares for income 

Around this time last year, shares in Lloyds supported a dividend yield of around 5.3%, or 3.2p per share. If the lender reinstated its dividend at this level in 2021, investors would be in line for a yield of 8.8%. 

View of Canary Wharf

While the bank might have the capacity to restore its dividend at this level, I think it’s unlikely. As the coronavirus crisis continues to rumble on, I reckon it’s more likely we’ll see a smaller payout to start from the group this year. 

Following a token payout this year, I reckon management will adopt a progressive dividend policy in the years ahead. I should note that these are relatively conservative projections. In the most optimistic projections, the bank could distribute billions as a special dividend to the holders of Lloyds shares. That’s based on the group’s latest capital figures. 

Capital reserve 

When policymakers decided to ban bank dividends at the beginning of last year, they were worried that lenders would use up their capital buffers, which is what happened in the financial crisis. However, the opposite has happened. Rather than using up their capital buffers, these reserves have only increased. 

In November, Lloyds reported a Common Equity Tier-1 ratio of 15.2%. At the end of 2019, the ratio was 15%. This was significantly above management’s minimum required level of 13.5%.

When the Tier-1 capital ratio hit 15% in 2019, Lloyds declared a final dividend of 2.25p per share, totalling £1.6bn. I think this capital figure only increased during the last three months of the year. That suggests Lloyds could return substantially more than the £1.6bn payout it distributed for 2019. 

I think these numbers mean investors could see a final dividend for 2020 of around 2.5p to 3p per share in the best-case scenario. This suggests the stock could provide investors with a dividend yield of 7% to 8.2%, based on my figures. Even in the most basic scenario, I can see the stock offering a yield of around 3%, or in line with the market average, in 2021. 

Those are the reasons why I’d buy Lloyds shares for income in 2021. Now that the bank is allowed to resume investor returns, I believe the stock could become a cash cow for shareholders in the years ahead.

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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.

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