Lloyds Banking Group (LSE:LLOY) shares offer some of the biggest dividend yields on the FTSE 100, based on current dividend forecasts.
At 43.1p per share, the yield on the Black Horse Bank for 2023 sits at an enormous 6.5%. This sails above the 4% forward average for Footsie shares.
Yields move even higher for the following two years too. Readings jump to 7.4% and 8.4% for 2024 and 2025, respectively.
Lloyds’ share price is largely unchanged on a 12-month basis. But growing fears over the state of the UK economy have caused the bank to sink by almost a fifth since the beginning of February.
Do the huge yields created by the bank’s price collapse make it a brilliant buy? Or does the prospect of further price falls make it stock to avoid?
Solid forecasts
First it’s worth considering how realistic current dividend forecasts are. Shareholder payouts have risen strongly from the depths of the Covid-19 pandemic, and City analysts expect them to appreciate again to 2.8p per share in 2023 from 2.4p last year.
Dividends of 3.2p per share for 2024 and 3.6p for 2025 are also predicted.
A quick glance at earnings forecasts suggests that Lloyds will be in good shape to meet these dividend estimates. Predicted payments are covered between 2.3 times and 2.7 times by expected profits over the next three years. Any reading above 2 times provides a wide margin for error.
Then there’s the bank’s strong balance sheet to consider, which provides dividend forecasts (in the near term at least) with added strength. Lloyds’ CET1 capital ratio stood at a robust 14.6% as of September, still well ahead of the 12.5% target and 1% management buffer.
In fact, some analysts believe the bank’s strong capital position may lead it to launch additional share buybacks. The firm completed repurchases of £2bn during the summer.
NIM trouble
That said, Lloyds faces increasingly choppy waters that might threaten dividend projections next year and beyond, and keep its share price locked in its recent downtrend.
One reason is because net interest margins (or NIMs) look set to come under increased pressure. These are a measure of the difference between the interest firms offer savers and what they charge borrowers.
Falling inflation is feeding speculation that interest rates have peaked. In fact, predictions that the Bank of England may begin cutting rates from the spring is heating up.
At the same time, pressure from the Financial Conduct Authority to lift savings rates — combined with increasing industry competition — casts a shadow over NIMs.
I’m avoiding Lloyds shares
Falling NIMs aren’t retail banks’ only worry either. Demand for their loans could splutter should (as most economists predict) the British economy remain weak over the short-to-medium term. The degrading housing market is especially problematic for Lloyds too, given its position as the country’s biggest home loans lender.
Finally, a steady growth in loan impairments also poses a considerable threat to profits and dividends. The firm booked another £187m worth of bad loans during the third quarter alone.
Lloyds has leading positions across multiple product areas. And this could help stabilise earnings during these tough times. But on balance I’d still rather buy other UK shares for dividend income today.
