Why Lloyds remains a dividend story

Lloyds has hardly been out of the news this week. A plunge in equity markets and a lower-for-longer interest rate environment has forced City analysts to rethink estimates for the high street lender. And Royal Bank of Scotland's£2.5 billion hit to profits yesterday put banks in the spotlight again.

Long-time fan JP Morgan has just trimmed its price target on Lloyds to 90p, UBS goes from 97p to 88p, and Berenberg's James Chappell is a seller down to 55p. Now, it's Nomura's turn to tone down the rhetoric.

"Lloyds is a dividend story. It does not have growth backing its investment case, given it is focused on margin protection, and lower-for-longer rates do not help earnings," explains respected analyst Chintan Joshi.

"With a much improved capital position, our hope was that payment protection insurance (PPI) provisions would be spread through time, allowing gradually improving dividends and a surprise versus market expectations."

But last October the Financial Conduct Authority (FCA) set a time-bar on PPI claims at 2018. Nomura now expects Lloyds to take a £3 billion PPI provision for the fourth quarter of 2015, which will allow a 2.25p dividend per share (DPS) for the full-year, a quarter of a penny below consensus.

"If the regulator is more negative, then we expect £4 billion provision in fourth-quarter with a 1.5p DPS for FY15," says Joshi. "The crucial point here is that, if there is no increase in the cumulative quantum of PPI provisions, there should not be a change in the cumulative quantum of dividends."

However, erring on the side of caution, Joshi increases his estimate of PPI provisions by £0.5 billion to £5 billion, and leaves forward dividend estimates unchanged for now.

"With the stock trading at c1.2x 15E price/tangible book value ratio against a 17/18E return on tangible equity of c14.3% and an eventual top decile dividend yield, we continue to be constructive on the name."

Joshi keeps a 'buy' rating on Lloyds, but, following a 28% slump from last year's high near 90p to a two-and-a-half year low now, nips 5p off the price target to 90p.

Elsewhere, the broker thinks Barclays will need to make £2.3 billion of PPI provisions by 2018, including £1.5 billion in the fourth quarter of 2015. It's also more optimistic on margins than many others. Margins should continue to improve this year, says Joshi, before stabilising in 2017, then falling back to third-quarter 2015 levels the year after.

Brexit is also highlighted as a negative for UK banks, but it's not Nomura's base case scenario:

"Tactically, we would avoid UK banks into the referendum but, with 20% of voters undecided, we assume that the UK will remain in the EU. Strategically, therefore, we focus on fundamentals and reiterate preference for Lloyds in the UK."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.