2016 has been a volatile year for Lloyds (LSE: LLOY) as Brexit, talk of an end to PPI claims and BoE decisions have sent shares see-sawing up and down. The past month has been no exception, although in this case it’s been a positive as shares are up over 6% in value. As the dust settles from post-Brexit panic and shares again begin to climb upwards, is now the time for investors to buy into the Lloyds story?
Answering that question requires asking ourselves a few questions, namely, how is Lloyds performing and what’s the outlook for the UK economy?
We begin on a positive note as Q3 results released in October did flaunt the relative health of Lloyds compared to its challengers. Its operating costs as a percentage of income remain well below competitors’ at 47.5% and its CET1 capital buffers increased to a very healthy 13.4%, giving management more breathing room to increase already-solid dividend payments.
Perhaps the best bit of news was that the bank expects the £1bn it earmarked this quarter for PPI provisions to be its last. Putting this £17bn saga behind it will be immensely rewarding for shareholders as it will mean more profits can be returned through dividends and share buybacks in the coming years.
Dividends are key
There’s no doubt that these dividends will be the main driver of interest in Lloyds. Due to the bank’s already huge size, it originates around 20% of all domestic mortgages, there’s little room for top-line growth outside of acquisitions. Likewise, with operating costs already quite low and interest rates going even lower, organic profits are unlikely to rocket anytime soon.
And just like all banks, Lloyds’ health is inexorably tied to the health of the domestic economy. This is even truer for Lloyds because, unlike HSBC or Barclays, it doesn’t have considerable overseas operations to fall back on in lean times. As the healthiest and largest retail bank in the country, its share price is also as likely to move based on macroeconomic news as the actual results of the business itself. That’s why share prices are still down more than 15% from their closing price the day before the EU Referendum.
The good news is that the few post-Brexit economic sets of data we’ve received paint the picture of an economy that’s largely resilient. Unemployment numbers are still very low and while housing prices in the South East are experiencing trouble, overall housing demand remains strong.
So, it doesn’t look like the bottom is about to fall out on the economy and drag Lloyds shares down with it. Add in a dividend yield that currently sits at 3.92% and it’s clear why many retail investors are interested in Lloyds shares. Furthermore, if the mooted purchase of MBNA’s credit card business goes through, Lloyds could also see its share of the high-margin UK credit card business rise to around 25%. This would be a major boost to Lloyds profitability at a time when low interest rates are cutting into net interest margin. Buying Lloyds shares now is a bet on the health of the domestic economy, but with dividends rising and lower costs than competitors, there are certainly worse options for exposure to the banking sector.
