Is Lloyds on the mend?

While Lloyds is far from out of the woods, experts are working to get the bank back on its feet. So, if you fancy a punt on a recovery, says Bengt Saelensminde - buy this preference share.

The amount of people that ask for my opinion on Lloyds is amazing. Maybe it shouldn't be. Morningstar has Lloyds as the most traded stock on the market. Even if you're not a trader, there's a good chance you hold stock as a legacy of the TSB or HBOSmerger.Or maybe you still hold some stockfrom the good old days when it used to be a nice little yielder.

Today I want to give you my honest opinion on Lloyds and show you what I thinkarethe best Lloyds shares to buy. And it's NOT the ordinary shares most people punt on!

Now, let me just kick off by saying I don't feel good about the banking industry it's still in intensive care. But then again, the industry has got a fantastic team helping to nurse it back to recovery. It's got to be worth at least considering if there's a possibility of recovery...

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

We are all filling the blood banks

Of course there have been other disasters too. Especially the personal loan insurance scandal. They can't blame it all on the HBOS deal.

But as I said, the industry has a well-respected specialist care team behind it. Money is to a bank what blood is to a patient. The transfusion is in place, and we're all helping to fill the blood banks.

The bank's treasury departments have been flooded with cash. All manner of liquidity schemes are in place allowing the banking industry practically free access to the stuff. And it's not difficult to run a profitable business when your inputs are free!

On the face of it, Lloyds is looking in much better shape now than it has for years. Analysts have pencilled in a £2.7bn profit for this year. OK, so that's not back to pre-crash levels (2007 profit of £4bn), but it's certainly a step in the right direction.

Under attack from all angles

For starters, there are a lot more shares in issue today than in 2007. The government alone now owns 43% of the newly merged business and then there are all the other old HBOS shareholders too. With so many shares now in issue it means that even with £2.7bn of earnings, at today's price, the shares would still be on a racy 23 times earnings.

And there's more...

The banking business model is being attacked from all sides. The regulators are desperately trying to stem the bad-boy City stuff. But life is tough on the high street too.

Small businesses and individuals are a lot more wary of the services' supplied by the high street banks. From expensive currency transactions, to insurance, or even more esoteric products like interest rate swaps.Punters are beginning to realise the banks are out to scam them.

A lot of what a bank used to do is shifting to cheaper internet-based alternatives. It's not just high street retailers that are suffering it's the banks too.

And then of course, there's the risk that the financial crisis will re-emerge. If the 2008/09 crisis taught us anything about the banking sector, it was the interconnectedness of it all. In that case, it was US subprime that infected the rest of the banking community. Next time round, the disease may well emerge in Europe, or Japan... or anywhere, I don't know. But I strongly suspect we haven't seen the last of the banking crisis.

Notwithstanding my concerns about the health of the banking sector, one thing's for sure. Lloyds profits are looking much better. In fact, so much so that management is appealing to the regulators to allow it to reinstate the dividend for ordinary shareholders.And that's what most investors are after. A recovery, and a decent dividend payback. So let's tackle that...

The best way to grab Lloyds' dividend

about preference shares

Lloyds has several prefs in issue, but today I want to look at the Lloyds 9.25% pref. It pays 9.25 pence per share, per annum. And with the shares trading at £1.05, it's paying a rather handsome near-on 9% running yield.

Here's a five year chart of the prefs (pink) versus the ords (blue)

Lloyds 9.25% Non-CumIrredeemablePreference



As you can see, the financial crisis of 2009 dragged down both classes of share. But then the paths of the two types of Lloyds share parted company.

Though dividends on both classes of share were cancelled (an EU imposed restriction), the prefs promptly recovered.

Why? Two reasons:

First, the dividend on the prefs was always likely to be re-instated way before the ords got a look in. And that's exactly what's happened. As of the beginning of this year, the prefs are back in business.

But secondly, and more importantly, unlike the ords, the prefs haven't been diluted. That is, no more prefs have been issued during these crisis years. So, now that the dividend has been reinstated, it's paying a full 9.25p per share.

As for ordinary shareholders, Lloyds is currently in negotiations with the EU regulators to see ifit can win back the right to issue dividends. Now, even ifit doeswin this battle, it's certain to be a long, long time before the dividend gets back to anywhere near the levels that it used to be.

At the same time, I think it's worth noting that if the banking industry suffers another blow-up, then it's likely to be the ordinary shareholders that suffer.

The prefs look far less exposed. AND they're earning a pretty useful income.

Betting on a healthy banking system

But, bear in mind that if bond holders (and prefs) are to take losses, then the ords are likely to be totally wiped out. That's why I still advise caution with the sector as a whole.

In my opinion there's still too much risk in the banking system to consider investing in Lloyds. But if you still want to go for it, then why not do yourself a favour and at least secure yourself preferential treatment. Lloyds 9.25% preference shares are traded in London under the ticker LLPC.

This article is taken from the free investment email The Right side.

Sign up to The Right Side here.

Important Information Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

The Right Side is an unregulated product published by Fleet Street Publications Ltd.

Fleet Street Publications Ltd is authorised and regulated by the Financial Services Authority. FSA No 115234.