It is summer 2007. Shares in Lloyds (LSE: LLOY) have been getting close to the £3 mark again. The annual Lloyds dividend has been raised 5% to nearly 36p per share. What could possibly go wrong?
The answer, we now know, lay in the financial crisis. At the bank’s annual meeting a couple of years later, the then chairman told shareholders: “The board and I are sorry about the decline in our share price and the financial difficulties that the temporary suspension of our dividend have caused shareholders”. That “temporary suspension” was to last until 2015.
Now 15 years on from summer 2007, the annual dividend is less than a 10th of what it was. The shares trade for pennies, as they have done ever since the financial crisis. With a recession looming, what might be in store for the Lloyds dividend this time around?
In better shape
That financial crisis changed a lot of things for British banks. I think Lloyds is in much better shape now than it was then. It has a larger margin of safety in how its business is capitalised and run. That could help it handle any financial downturn much better than it was able to do a decade and a half ago.
Not only that, but what happened in 2007 was a global financial crisis. A recession would not necessarily test a bank like Lloyds anywhere nearly as badly. In fact, a recession could possibly help the Lloyds business in some ways. For example, to try and combat high inflation, interest rates are rising. As the UK’s biggest mortgage lender, that could help boost profits at Lloyds.
But clearly a recession would bring risks. If it is very bad, defaults on loans will likely increase and that could hurt profits at Lloyds.
Will the Lloyds dividend survive?
No dividend is ever guaranteed and that is true at Lloyds like any other company. But the company has been conservative in its recent payouts. They are still well below where they were even before the pandemic, let alone back in 2007.
But the bank has been generating huge amounts of excess cash. This year it has been spending £2bn on its own shares. That suggests it has substantial funds it thinks are surplus to business needs, even after allowing for a capital cushion.
Recently, the interim dividend was increased by nearly 20%. Paying that will cost the bank around £550m. But the profit after tax for the first six months of 2022 was £2.8bn. In other words, the interim dividend is covered by earnings more than five times over.
For now, then, the Lloyds dividend seems to have a large margin of safety. The bank has a “progressive and sustainable” dividend strategy that could see the payouts keep growing even amid a recession.
However, dividends are never guaranteed. Although I think the Lloyds dividend could survive a recession, it would depend on how bad the economy got. The deeper the recession, the worse it might be for bank earnings – and the Lloyds dividend. For that reason, I have sold my shares.
I feel some businesses may be much less exposed to the impact of a recession than banks. I have been buying such shares lately.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.