Lloyds Weathers the Storm

Lloyds TSB's (NYSE: LYG) recent announcement that it experienced slower growth in consumer lending and higher defaults in its consumer segment did not come as a surprise, and its stock actually went up on the news.

Lloyds Weathers the Storm

Lloyds TSB’s (NYSE: LYG) recent announcement that it experienced slower growth in consumer lending and higher defaults in its consumer segment did not come as a surprise, and its stock actually went up on the news. One reason for that is that the company says its dividend will not suffer, even despite the uneasy economic situation in the United Kingdom.

Consumer lending represents about a third of Lloyds’ profitability. The rest comes from wholesale banking (corporate) and life insurance. Both of those businesses are firing on all cylinders. In first half of 2005, the wholesale banking business saw a decrease in bad debt as corporations in the U.K., like their counterparts in the United States, are swimming in cash. The life insurance business was a very solid performer over this period as well. I am not particularly worried about Lloyds weathering the consumer storm that is currently raging in the U.K., since the company is more than sufficiently capitalized and very well managed and diversified. I am far more concerned that we are seeing a “Mini-Me” version of a massive financial hurricane that will soon hit the U.S. It appears that the U.K. is about one economic cycle ahead of the U.S.: The former’s housing market has been cooling for a while, its central bank was lowering rates until recently, and its consumer spending was slowing while consumer defaults were rising. And consider this: U.K. consumers are not nearly as leveraged as their U.S. cousins.

The decline in housing prices in the U.S., coupled with higher short-term interest rates and rising energy prices (heating bills alone are expected to be 70% higher than last year), should be a cause for alarm. To throw gasoline on the fire, minimum credit card payments will double in January. The combination of these factors is likely to have a significant impact on the highly leveraged U.S. consumer, putting a great squeeze on consumer discretionary income and, thus, spending.

Lowe’s (NYSE: LOW), Home Depot(NYSE: HD), Best Buy(NYSE: BBY), and a myriad of others that are closely tied to consumer discretionary spending and home equity borrowing are likely to be the first casualties when a much larger version of the U.K. financial storm hits the U.S. coast. Financial institutions that rely heavily on consumer lending, such as Capital One(NYSE: COF) and MBNA(NYSE: KRB) — soon to be bought by Bank of America(NYSE: BAC) — are likely to be not far behind them.

As for Lloyds, its monster 7.3% dividend will not be negatively affected by the consumer weakness in the U.K. The press release was firm about that. And that is one reason why the stock went up on bad but expected news.

As Lloyds’ executives have stated many times before (and I believe them), there are only two reasons to cut a dividend: There is not enough capital, or the capital is needed to grow the business. Neither is an issue here. The company is well-capitalized, and it has excess capital for a rainy day. Nor it is not planning to make large acquisitions, so there is no reason to build up a war chest.

Lloyds TSB is one of only two non-government-backed banks that command a triple-A rating from Moody’s (the other one is Wells Fargo). The company remains on very solid ground and if anybody can weather the storm — while continuing to pay a dividend — Lloyds certainly can. Home Depot and Lloyds areMotley Fool Inside Valuerecommendations. Best Buy is aMotley Fool Stock Advisorselection, and Bank of America was recommended by Motley Fool Income Investor.

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