Lloyds has announced it will not be paying any dividends or buying back any shares in 2020 as it seeks to preserve capital during the COVID-19 pandemic. The decision includes the final dividend of 2019 and was taken in tandem with the other UK banks following a request from the Bank of England.
The board will decide on any future dividend policy and amounts at year-end 2020.
The shares fell 6.3% in early trading.
The news that Lloyds, along with the other major UK banks, is suspending shareholder returns doesn't come as a surprise.
The government and Bank of England (BoE) have taken drastic action to free up banks' capital and encourage lending to smaller business. Paying out surplus capital to shareholders in that environment was never going to go down well, and the BoE has (to all intents and purposes) instructed banks to scrap any dividends until next year.
But preserving capital may be no bad thing. The months ahead look set to be tough for the sector.
We've already seen several companies file for bankruptcy, and as the lockdown drags on we expect to see more. That means a rise in loan defaults which will eat into the bank's profits and ultimately capital. Widespread uptake of mortgage holidays and debt relief would also reduce cash coming through the door.
Even financially sound businesses will be leaning heavily on their bankers in the months to come. As many businesses see sales fall to near zero, borrowing is the only way to meet expenses and that means drawing on existing loan facilities and looking for new ones. Banks' key capital ratios are calculated by dividing available capital by 'risk weighted assets' or 'RWAs'. As loans to customers increase, RWAs increase and capital ratios fall (even if available capital remains unchanged).
The move by the BoE to cut rates to just 0.1% (a record low) in March was also bad news for the sector. The lower interest rate will largely be passed onto borrowers thanks to a combination of base rate tracking loans, competition and regulatory action. But the interest banks pay to savers is already on the floor. With little room to push funding costs lower the net interest margin (the difference between what the bank can make on loans and pays for funding) will be squeezed. That will significantly reduce the profitability of loans.
Looking at Lloyds specifically, the recent shifts towards credit cards, car finance and unsecured loans has increased the risk profile of the loan book. When times get hard defaults in these areas rise. However, mortgages continue to make up the vast majority of the bank's assets, and these are generally considered safer loans. The shutdown of the UK property market will mean new loan growth grinds to halt but, if we avoid a severe recession, that should create some pent up demand for the second half of the year.
The bank also generates a significant portion of its profit from its wealth and insurance businesses -the Schroders Personal Wealth business and Scottish Widows. How recent market movements end up affecting the insurance business in particular is unclear at this point, but it role in diversifying income is important. We don't expect demand for the product to disappear.
There is some good news hidden among the doom and gloom. Banks generally, and Lloyds specifically, are significantly better capitalised today than they were before the financial crisis. While the next few months will be difficult that should allow the sector to hopefully weather the storm without the painful bailouts of last time around.
The length of lockdowns and strength of the eventual recovery will determine the extent to which the bank has to wind down its capital reserves. Until those reserves are adequately replaced the dividend is likely to stay on hold. How long that will take is impossible to say, but do bear in mind supporting the bank through a downturn is why they're there in the first place.
Full Year Results (20/02/20)
Net income fell 4% year-on-year to £17.1bn, with both interest and other income falling. Together with an increase in bad loans that more than offset a decline in operating costs, with the result that underlying profits fell 7% to £7.5bn.
A substantial PPI related charge meant reported earnings per share fell 36% to 3.5p. The bank announced a final dividend of 2.25p, taking the full year payment to 3.37p per share, up 5% year-on-year. The dividend will be paid quarterly in the future.
The bank guided for a relatively benign 2020 despite difficult macro-economic conditions.
Net interest income fell 3% year-on-year to £12.4bn, as loans to customers fell slightly and bank's net interest margin (the difference between what the bank charges on loans and pays to borrow) declined to 2.88%.
Non-interest income fell 5% in 2019 to £5.7bn. That reflects declines in Commercial Banking and Retail as large corporate clients reduced their activity in a challenging market and the number of car-finance contracts declined. Weaker prices for used cars in the group's Lex-Autolease business also weighed on results.
Operating costs fell 4% over the year to £7.9bn, as the group continued to digitise more repetitive processes. The group's cost:income ratio continues to fall despite the drop in income, and now stands at 48.5%.
Bad loans rose 38% during the year to £1.3bn, that primarily reflects two large commercial customers but also the weakening used car prices.
The bank reported a substantial PPI charge during the year of £2.45bn, up from £750m last year.
Lloyds finished the year with an underlying CET1 ratio (a key measure of banking capitalisation) of 13.8%, down 0.1 percentage points from last year after paying the dividend. The bank generated 0.86 percentage points of capital during the year.
Underlying return on tangible equity fell 0.7 percentage points to 14.8%.
The bank forecast a net interest margin of between 2.75% and 2.80% next year, with operating costs of less than £7.7bn and a cost:income ratio below 2019. The bank expects generate between 1.7 and 2 percentage points of capital.
The author owns shares in Lloyds Banking Group.
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