Lloyds Banking Group’s (LSE: LLOY) latest results show the business is making substantial progress in its efforts to turn itself around. While statutory pre-tax profits missed analysts’ forecasts amid a further increase in its PPI provisions, Britain’s biggest mortgage lender was optimistic about its underlying financial performance.
It has remade itself into a very profitable bank with metrics that the other big four banks could only dream about. And although its shares have recovered strongly post-Brexit, there are a number of bullish catalysts ahead that could lead to further gains in its share price.
Rising interest rates
First, the outlook for rising interest rates bodes well for future earnings, as it is expected to improve the profit spread between the interest income it generate and what it has to pay out to lenders, ie those of us who deposit our money there. That’s its net interest margin.
The bank seems to be already benefitting from the Bank of England’s decision to increase its base rate by 25 basis points, as net interest margins in 2017 widened to 2.86%, from 2.71% in the previous year. Looking ahead, Lloyds reckons its net interest margin could rise still further, giving guidance of around 2.9% in 2018.
As well as growing its interest income, Lloyds has ambitious plans to expand its financial planning and retirement propositions. It has set itself a target to grow its open book assets by more than £50bn by 2020 with more than one million new pension customers.
PPI deadline
Also, not long from now, payment protection insurance (PPI) claims should start to fall as the August 2019 deadline to claim compensation approaches. This would end a major drag on its earnings, which has so far cost the bank more than £18bn in profits since the financial crisis.
If we set aside these PPI provisions, along with other non-recurring costs which included its restructuring and other legacy misconduct charges, Lloyds would have earned a return on tangible equity (RoE) of 15.6%. Instead, its statutory RoE was just 8.9% in 2017 — though that still exceeded most of its major competitors and was an improvement from the 6.6% figure from the previous year.
Growing shareholder payouts
An outlook for improving returns brings me to my third reason — growing shareholder payouts. Lloyds’ dividend was suspended during the last financial crisis, but the stock is rapidly becoming one of the FTSE 100’s top dividend stocks.
Since the bank returned to dividend payments in 2014, it has delivered impressive growth in annual dividends year after year, supported by strong capital generation and its robust balance sheet. Most recently, it announced a 20% increase in its 2017 payout, with full-year ordinary dividends totalling 3.05p per share.
And it’s not just through dividends that the bank is returning cash to shareholders. This week, management also announced a share buyback of up to £1bn, which would bring total capital returns from the bank to around 46% for 2017.
Looking ahead, I expect capital returns to rise to more than a majority of its capital generation as returns continue to improve. City analysts seem to agree, with a consensus dividend forecast of 4.4p in 2018 giving it a prospective dividend yield of 6.5%.
