Lloyds dividend hopes under threat from UK banks stress test

LONDON (Reuters) - Lloyds Banking Group Plc risks rejection of its plans to pay a dividend for 2014 unless it performs strongly in a British test of its financial health, results of which are due to be published next Tuesday.

Lloyds, along with state-backed rival Royal Bank of Scotland , only narrowly passed a test by European regulators in October and now faces a more stringent examination by the Bank of England (BoE).

The BoE is testing how resilient Britain's biggest eight lenders would be in the face of a slump in house prices and higher interest rates and some analysts believe Lloyds is vulnerable in the test, which adds extra elements on top of those applied by Europe.

Industry sources say the emphasis on home loans in the BoE test means Lloyds, along with mutually owned Nationwide , Britain's two biggest mortgage providers, will come under pressure. "Lloyds will pass but it won't be the strongest pass," one of the sources told Reuters.

Lloyds has said it is confident it will pass.

The BoE is expected to order banks which fail or narrowly pass the test to take actions to strengthen their capital, which could include dropping or scaling back their dividends.

Banks will have to show that they would still have a core capital ratio of at least 4.5 percent of risk-weighted assets in stress scenarios including a 35 percent drop in house prices and a rise in interest rates to 6 percent.

Analysts at Citi expect Lloyds to pass the test, holding core capital of 5.7 percent under the stresses, though this would be the weakest result among Britain's biggest four banks.

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Lloyds has been in talks with the regulator to start paying dividends for the first time since it was rescued by the government during the financial crisis of 2008 to 2009 and wants to hand shareholders a modest payment.

Analyst Ed Firth at investment bank Macquarie said there was a risk Lloyds might fail the BoE's stress test and didn't expect the bank to be able to pay a dividend until 2015, though he did not see it needing to raise funds.

"Whilst we do not see failure as having capital-raising implications, we no longer expect Lloyds to pay a 2014 dividend," Firth said.

If the regulator blocks Lloyds' dividend plans, it could make it harder for the government to sell off more of its remaining 25 percent shareholding in the bank.

Royal Bank of Scotland , 80 percent state-owned, will also be under scrutiny after saying last month it had only just passed the European test in November, after initially submitting incorrect data which made it appear to have passed comfortably.

RBS and Lloyds only narrowly passed the European test, holding core capital of 5.7 percent and 6.2 percent against a 5.5 percent pass mark. HSBC and Barclays passed the EBA test more comfortably, holding core capital of 9.3 and 7.1 percent respectively.

(Editing by David Holmes)