Lloyds’ (LSE: LLOY) recovery is finally well under way, and the bank is starting to put the mistakes of the past behind it.
Indeed, Lloyds’ first-half results ticked all the right boxes. Profits jumped 38% during the six months to June, the bank’s fully loaded tier one capital ratio rose to 13.3% and the group’s cost/income ratio was a market-leading 48%.
What’s more, Lloyds has now started talking about returning surplus capital to investors, which could mean that is preparing to announce a special dividend this year.
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Well timed
There is one key catalyst that could force Lloyds to announce a special payout for this year, and that’s the new dividend tax regime that’s set to come into force next year.
From next April, the way dividends are taxed will change. The dividend tax credit will be abolished and will be replaced with a dividend tax allowance of £5,000 per year. Any dividends above the new £5,000 tax-free limit will be taxed according to the investors’ income tax bracket.
Basic-rate tax payers will pay 7.5% on dividends over the £5,000 limit. Higher-rate tax payers will pay 32.5%, and additional-rate taxpayers will pay 38.06%.
It is believed that before these changes come into force, there will be a rush of companies announcing special dividends, to help shareholders reduce their tax bill. And, as Lloyds has the largest number of retail investors of any FTSE 100 company, management could seek to help investors work their way around tax rules by issuing a special payout this year.
Capital return
While it would make sense for Lloyds to issue a special dividend before new dividend rules come into force, regulatory issues may prevent the bank from making such a move.
Nevertheless, the bank is committed to returning capital to investors over the long-term. Within Lloyds’ first-half results release management stated that:
“…we expect ordinary dividends to increase over the medium term with a dividend payout ratio of at least 50 per cent of sustainable earnings. In addition, going forward the Board will give due consideration… to the distribution of surplus capital…”
Surplus capital represents capital over and above the amount Lloyds requires to grow the business and meet regulatory requirements. At present, Lloyds estimates that the minimum level of capital required for the business is around 12% (tier one equity ratio).
And based on Lloyds’ improving financial position, as well as cash generation, City analysts believe that the bank could return £20bn to £25bn to shareholders over the next three years. Based on the fact that Lloyds intends to return 50% of earnings to investors via ordinary dividends, the bank is set to return 20p per share in ordinary dividends by 2018. Further, based on the bank’s existing capital position, 10p to 15p of additional capital distributions could be on the cards. Overall, Lloyds could return 43% of its current market cap. to investors by 2018.
So all in all, Lloyds could be gearing up to announce a special dividend towards the end of 2015. However, even if the bank is prevented from making a one-off payment this year, Lloyds could return billions to investors during the next three years.
