I’ve held Lloyds Banking Group (LSE: LLOY) shares for a little over three years now, and every time I look at the latest set of positive figures I typically sigh and think “maybe the share price will do better next year.”
Since I bought at 76p, the shares have lost 27% of their value. I have had a total of 12% in dividends over that time, which offsets the capital loss a little. But it’s still a disappointing performance, especially as forecasts for Lloyds continue to look good.
The dividend yield, for example, is expected to rise to 5.7% this year and 6.2% next, with the payments more than twice covered by predicted earnings. But we have seen bank dividends slashed before, so could the same happen to Lloyds should we see a Brexit-led assault on the banks next year? And what’s the bank’s liquidity looking like now?
Stress test
Results from the Bank of England’s latest stress tests were out on Wednesday, and they put the tested banks under a simulated crisis that involved a rise in base rates to 4%, a 4.7% reduction in GDP in the first year, rising unemployment peaking at 9.5% in the second year, and three-year slumps in housing and commercial property prices of 33% and 40% respectively.
And even in such a calamitous scenario, the modelling puts Lloyds on a transitional CET1 ratio of 9.3% after expected management actions, and that’s comfortably ahead of its increased hurdle rate of 8.5%. Similarly, a predicted leverage ratio of 4.5% compares well to a hurdle rate of 3.8%.
Lloyds needs to take no action as a result and, in fact, currently enjoys a CET1 of 14.6% and a leverage ratio of 5.3%, which is a very healthy-looking position. I really am not worried about the bank’s liquidity.
Downside
Royston Wild this week aired the reasons he’d sell Lloyds, and the bank is certainly not without risk. One is that a no-deal Brexit scenario will hit British businesses badly. Even without much direct exposure to Europe itself, Lloyds could suffer falling earnings if loans to businesses fall and, perhaps more worryingly, if bad debt should build up.
A widely feared fall in property values could hit mortgage lending too, and any slip towards a negative-equity market would… well, we saw what that did to the banks in the previous lending crisis. But looking at the continuing rosy figures from the UK’s housebuilders leads me to seriously doubt any such thing will happen — and mortgage lending today is considerably more prudent than the reckless days before the banking crash.
PPI
There’s PPI too, and though the upcoming end date will cut off any further compensation claims after August 2019, banking shareholders should expect a last-minute rush before the deadline. I’m certainly expecting it.
So yes, there are risks for sure, and the mooted dividend rises are by no means assured. But looking at the bottom line, I really see a share price valuation that puts Lloyds on a P/E of just over seven — only around half the FTSE 100‘s long-term valuation — as factoring in all of the justified pessimism, plus extra exaggerated levels of fear.
I’m still holding.
