Until 24 June, Lloyds‘ (LSE: LLOY) outlook was relatively bright. Indeed, the bank was reporting some of the best figures in the UK banking industry with a return on equity in the high double-digits, a sector-leading tier one capital ratio and plans to nearly double its dividend payout over the next few years.
Unfortunately, since Brexit Lloyds’ outlook has now completely changed.
Brexit risks are rising
As one of the UK’s largest domestic banks and the largest mortgage lender, Lloyds is highly exposed to the UK economy. Cracks are already starting to show in the economy after Brexit as the Bank of England has introduced emergency liquidity measures, property funds have stopped redemptions, the value of the pound has collapsed, and shares in domestic companies have plunged.
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These effects are likely to have more of an impact on Lloyds than other companies. Brexit has sent a shockwave through the UK’s property market, and if the moves in UK property shares, as well as the actions of commercial property fund managers are anything to go by, the sector is experiencing a sudden slump in demand. If this is really the case, Lloyds will be hit by both lower demand for its mortgages and increased stress on its mortgage portfolio as property prices decline.
Moreover, the Bank of England has hinted that it will cut interest rates further over the summer. Lloyds relies on the interest rate spread to make money. Simply put, the interest rate spread is the difference between the rate Lloyds pays depositors and charges borrowers. The lower the base rate, the tighter the interest rate spread will become, squeezing Lloyds’ income stream.
So, if the Bank of England does go ahead and cut interest rates over the summer, Lloyds is unlikely to meet City forecasts for growth for the next year.
Dividend hikes off the table
Another of the Bank of England’s monetary easing measures aimed at staving off a credit crunch following Brexit is the relaxation of rules that require banks to hold additional capital to protect against downturns. The total value of the capital withheld is £5.7bn and by freeing up this cash, banks will be able to lend an additional £150bn to households and businesses. Lloyds is already over-capitalised by choice, so it’s unlikely this move will make a big impact on the bank’s earnings in the near-term.
Bank of England Governor Mark Carney announced that banks wouldn’t be allowed to increase dividends as a result of this easing measure. Therefore, it looks as if Lloyds’ dividend payout is going to be stuck at 2.25p for the foreseeable future. Previously, City analysts had expected management to increase the payout to 3.8p this year for a yield of 7%. A further dividend increase to 4.1p for a yield of 7.5% was pencilled-in for 2017.
Overall, after Brexit Lloyds is facing a very uncertain future.
