This Bank Could Soon Be Free of Government Ownership

When the financial system came crashing down, the U.S. was not the only country where the national government took equity stakes in banks in exchange for capital. Similar situations have played out in such countries as Ireland and Greece, both of which had the added effect of the home country's insolvency. But here we will look at a British bank that after years of partial government ownership could soon return entirely to private hands.

Two bailout stories
Among the biggest government cash consumers in Britain were Lloyds Banking Group (NYSE: LYG  ) and Royal Bank of Scotland Group (NYSE: RBS  ) . Despite both banks requiring infusions of government money, they are in very different situations today.

Royal Bank of Scotland remains 81% owned by the U.K. government, with the latter having paid more for the shares than they are worth today. Since the bailout of RBS, numerous solutions have flown around as to how to solve the RBS issue. Some of the most common included:

  • a giveaway of RBS shares to taxpayers 
  • a complete nationalization of RBS
  • a sale of the government shares, even if done at a loss
  • a split of RBS into a "good bank" and a "bad bank"

But none of this has happened and RBS still remains virtually as government owned as it was when it was bailed out. RBS has a long way to go and the upside potential could eventually pay off. However, RBS requires a long-term holding time frame without collecting dividends.

Interestingly, many classes of RBS preferred shares trade well below liquidation and yield upwards of 7.5%. One example is RBS Preferred L Shares (NYSE: RBS-L  ) , which trade around 20% below liquidation and yield about 7.3%. Much of this is likely due to the uncertainty surrounding government actions and RBS.

In contrast, Lloyds is starting to emerge from government ownership as the government sold 6% of Lloyds in September, lowering its stake from 39% to 33%. While not a huge movement in itself, it shows the government's resolve to sell the Lloyds shares. As an added incentive, the Lloyds shares are being sold at a profit, making the sale more politically palatable.

But the removal of the government's stake has implications beyond simply removing it from the list of shareholders. Lloyds does not currently pay a dividend, largely due to the backlash the financial giant would expect to receive if it initiated a dividend while the government has not been fully repaid.

Looking at Lloyds dividend plans, shareholders could see some decent capital returns. The bank has already stated its intention to pay out up to 70% of its earnings as dividends in 2015, signaling a return of Lloyds to the dividend-paying club.

The bottom line
Lloyds is outperforming its Scottish rival in reducing its government ownership, a trend that could lead to both share-price appreciation and dividend increases. While RBS still has upside potential, uncertainty surrounds the bank, likely suppressing its share price at least until some plan has been agreed to.

Lloyds, on the other hand, could see its share price temporarily constrained as the government floods the market with shares. However, once the stock sales are finished, Lloyds has meaningful upside based on the reinstatement of a dividend and the removal of the government ownership mark. Investors looking to get into a recovering bank before the government sells the last of its shares should take a further look at Lloyds Banking Group.

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9/23/2016 4:02 PM
LYG $2.95 Down -0.08 -2.64%
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Royal Bank of Scot… CAPS Rating: ***
RBS-L $25.30 Up +0.07 +0.28%