Lloyds Banking Group PLC (LON:LLOY) is performing best of the big four banks but progress from here may be harder suggests Deutsche Bank even with a chunky dividend yield.
According to the German broker, Lloyds has the highest returns of any of the UK large-cap banks, strong organic capital generation, paid a trailing 4.5% cash dividend yield in 2016, and has limited income volatility.
The bull case is that if it can boost returns through sharply falling one-off items and/or improved earnings, this would be equivalent to 250bps (2.5%) of capital generation annually, a sum that would imply an 8% dividend yield (on 75% payout) or 11% on a 100% payout.
But Deutsche is slightly more cautious and says it will be hard for the bank to boost margins much as long as interest rates remain low.
With impairment rates already at near-record lows the risk is now to the downside and margin pressure will likely impact the business in 2018, which will mean Lloyds needs to increase loans and target more cost reductions.
Even so, Deutsche has tweaked up its dividend forecasts over the next three years and says a 6-7% cash dividend yield is attractive for income investors (and better than HSBC/other UK banks).
Its price target also rises, albeit by a smidgen to 70p from 68p, but that is 4% upside it said so the rating remains 'hold'.
Shares rose 1% to 68.3p.