Banks to drive UK dividend revival
Domestically orientated banks are presently one of the most interesting UK equity income prospects. Matt Hudson looks at favoured UK lenders and their potential as catalysts for a dividend recovery in the UK.
Lloyds and Barclays favoured
We favour Lloyds and Barclays as they continue to turn the focus back onto their retail and commercial operations, and see new opportunities in a range of smaller ‘challengers’, which offer both growth potential and attractive yields.
When we move to a higher interest-rate environment we expect this to be a positive for the sector.
Meanwhile, after enduring intense scrutiny from regulators in the past few years, the banks now enjoy much-improved capital positions.
The strengthening of their balance sheets should ultimately allow a greater proportion of earnings to be returned as dividends.
It was particularly encouraging to see Lloyds return to the dividend list at the start of this year and its rehabilitation ahead of reinitiating payouts could make it the ‘playbook’ for the Royal Bank of Scotland.
In August the government began to dispose of its holding, and arguably Lloyds’ rehabilitation started when the state first began to sell down its stake in late 2013.
Vanguard of the recovery
After a hiatus in 2013, UK dividend growth looks to be accelerating again in 2015.
This reacceleration is what you would expect as we move into the latter phases of the business cycle, and we anticipate dividend growth returning to its 5-6% nominal long-term trend level this year and next.
The banks are a good way of playing this dividend growth story, as they should be at the vanguard of the recovery.
The below graph illustrates how UK dividends as a whole have rebuilt following the financial crisis and recession of 2007/08.
Rather than the total amount of dividends paid by UK equities, which surpassed the prior peak a few years ago, the graph shows the like-for-like payout at the per share level.
It adjusts for the huge issuance in new stock which occurred in the aftermath of the financial crisis, and underlines how the market is on the cusp of recapturing the peak payout levels achieved before the downturn.
The last few years have seen a rebuilding of capital in the banking system and a greater focus on business lines that offer higher returns, less volatility and on lower capital requirements, such as retail and commercial banking, at the expense of investment banking.
The banks have also been forced by the regulator to improve their control systems, so have a greater understanding of where the risks in their businesses lie.
The banks are now seeing tangible benefits of their bigger and more diverse capital bases.
On the back of its 0.75p final payment for 2014, Lloyds re-initiated interim payments at July’s half-year results when it declared a 0.75p payout and pledged to make a further final distribution for 2015.
In addition, it said it would use any excess capital above the core tier one ratio of 13% for special dividends and share buybacks.
More income potential
The banks clearly have a lot of potential lost ground to recapture when you consider that in 2005 they paid an aggregate of around £13 billion of dividends, equivalent to approximately 26% of the equity market’s total distributions that year.
This year we expect UK banks to be paying about £11 billion, around 13% of the total, and half the peak level reached in 2005, so the recovery potential is clearly significant.
This will be a really important year for Barclays under its new chairman.
The market certainly welcomed his assumption of executive powers after the departure of the chief executive, in the hope of the restructuring plans being accelerated.
These plans have seen the bank move back to its core business of lending to small and medium-sized companies and mortgages and away from growing the investment banking franchise.
The new executive chairman announced at July’s interim results that this year’s total distributions would be held at 6.5p, however, we expect progressive payments to resume again once his enhanced restructuring plans begin to take effect.
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