Buying shares in Lloyds Banking Group – is now the time?

With the Bank of England warning the UK economy could shrink 14% in 2020 amid Covid-19 downturn, consumer banks such as Lloyds Banking Group are up against it to grow profits.

Fears over the depth of the fall in the economy explain why so far this year the bank’s shares are down over 50%. It’s a fall that has burnt my fingers since I unwisely tried to catch a falling knife early on in the crisis. I was too optimistic once the stock market began falling back in March. I picked up my shares in Lloyds at an average of 47p.

The dividend

Since buying my shares, the dividend has gone, as a result of pressure from the regulator. This is another blow to small investors and potentially given the buffers banks have been building up an unnecessary move, but that’s a separate argument. It has happened and now investors need to deal with it and hope the virus doesn’t spike again and the economy bounces back. The chances of this though are getting slimmer and slimmer.

In the best case scenario I’d expect the dividend to be reinstated at the same rate it was at, and not rebased. The longer the virus goes on for, the longer the wait will be for the dividend as I expect the regulator will keep pressure on the bankers to hold the line. Lloyds itself has said that it doesn’t expect to pay a dividend during 2020.

The announcement from the company said: “Our board will decide on any dividend policy and amounts at year-end 2020.”

If we look at how Lloyds’ dividend was going through, growth had been strong since the dividend was reintroduced back in 2015. Rising from 1.5p to 3.21p in 2018. As a result, the yield had shot up which was very attractive to income investors.

The results

As was the improving financial performance of the business overall. Although Q1 2020 results looked less impressive. With net income shrunk 10.6% year-on-year to £4.0bn as lower interest rates and increased competition weighed on performance.

Lower income in the Q1 period meant the cost:income ratio rose to 49.7%. Despite this, it is one of the better ratios from across the industry and that’s good for shareholders.

Look at the previous quarter, so Q4 2019, and the picture is a bit better when net income fell 4% year-on-year to £17.1bn, with both interest and other income falling. Together with an increase in bad loans that more than offset a decline in operating costs, with the result that underlying profits fell 7% to £7.5bn.

2018 set a tough benchmark for the company with profits rising sharply, but despite challenges, the bank’s results weren’t too bad up to the end of last year.

The bear case

Despite this, the share price wasn’t rising that far at the end of 2019, even though the stock market shot up after the general election. Probably a combination of the falling net income along with Lloyds’ focus on retail banking and the UK held it back compared to other income shares (which seemed out of favour as an investing style compared to high P/E growth stocks).

That along with the fact bank shares just seem to be out of favour. The share price chart of Barclays also shows a lack of growth even at the end of 2019 and the beginning of this year.

Barclays six month share price chart
Barclays six month share price chart

Now things have become more difficult for banks in a low interest environment. The investment case for the bank has weakened despite the share price drops. Provisions for bad debts are likely to have to go up given the lockdown to cope with coronavirus.

Lloyds is involved in car financing, an area that might come under increased scrutiny. They’ve also been granting relief to motorists. Black Horse, one of the UK’s largest motor finance companies, which is owned by Lloyds Banking Group, said it had already given more than 60,000 payment holidays.

Challenges facing the whole industry

There are many people who know more about the complex world of banking than me. Yet I think it’s clear the whole industry is facing some barriers to growth and more general challenges. Many of these are more systemic and deep-rooted than the immediate challenges thrown up by coronavirus.

Although dealing with issues specifically from coronavirus adds cost and complexity to already very complex businesses, for example, working from home in an industry that has serious cyber-security and regulatory requirements.

One of the bigger challenges is still Brexit. Remember that? There are still uncertainties about the terms of a trade deal between the UK and the EU. It has has been reported that many banks are continuing to beef up their plans to move operations into the EU to financial hubs such as Paris and Frankfurt. Planning for a no-deal scenario was already underway but the move is likely to add cost and complexity to banks already dealing with coronavirus.

Another is interest rates that are very close to negative. In the UK the official interest rate at the time of writing is only 0.1%. Other countries and the ECB already have negative interest rates which bankers have complained have cost the banks dearly. They argue the sector has already paid 25bn euros since the deposit rate went below zero back in June 2014. This has taken a chunk out of already slim profits.

The impact of the recession. As lending businesses banks are hit hard when the economy slows down and demand for loans dry up and customer default on repayments, known as bad debts. In April, rating agency S&P, lowered its rating for six UK banks including Barclays and Lloyds.

It said“Even under our base case of an economic recovery starting in third-quarter 2020, we expect bank earnings, asset quality, and in some cases, capitalization, to weaken meaningfully through end-2020 and into 2021,” it said.

The multinational banks have a bad reputation. This is encouraging customer slowly but surely to move to fintech rivals and this trend may well accelerate. The UK is the second-largest fintech in the market, behind the US, when measured by investment into companies. Monzo and Revolut are growing and seem popular with customers, especially tech-savvy millennials.

Reasons to invest in the shares when things improve

Lloyds has made strides with its move into wealth management, typically a higher margin activity than consumer banking. Especially in the current environment. The bank has big plans to grow in this area an compete with the likes of St James’s Place and Brewin Dolphin, both of which are far more expensive for customers.

Early indications are suggestive that the business is doing well. For example, in March the joint venture contributed £12.6bn of inflows to Schroders, which enjoyed record inflows of £43.4bn during 2019, more than quadruple the £9.5bn it took in the previous year.

Another area where Lloyds does very well, likely as the result of its tight focus on UK banking, is on keeping costs down. For a bank it is streamlined, helping deliver more value for shareholders. This is not something bigger banks like HSBC are good at doing with cost:income ratios far above Lloyds’ 49.7%. I think the discipline management shows in running the business is both reassuring and commendable.

On a similar note, the CEO, António Horta-Osório, is well-regarded and has been in a position for longer than rivals at most, if not all, of the other UK listed banks. He joined the bank in 2011 and although the share price hasn’t rocketed he has done much to improve the finances and image of the bank which should stand it in good stead long-term.

Finals words

Having said that, now is probably not the time to buy shares in Lloyds. Tuck it onto the watchlist as one of the best managed and run banks and wait for better economic conditions by all means, but there are less risky shares out there still paying a dividend and with more growth opportunities.

With the share price down over 50% in some ways the shares are less risky than they were, but any further stock market downturn is likely to hit the shares for six. The heavy share price doesn’t necessarily make the shares more attractive.

Please note I own shares in Lloyds Banking Group

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