One of the reasons I own bank shares is because financial institutions can sometimes make big profits – and that helps them pay large dividends. Right now, for example, the payout from Lloyds (LSE: LLOY) is looking attractive to me. It is getting closer to 5%, which I think is an appealing level for a bank dividend. But might the Lloyds dividend reach 5% — and what does that mean for my portfolio?
Falling Lloyds share price
Recently, the Lloyds share price has been falling. Over the past 12 months, it has slid 7%. So far this year, the shares have fallen 13%.
Meanwhile, the bank has raised its dividend. Last year, the total dividend was 2p per share. That was markedly higher than the previous year, when the dividend had remained suspended for part of the period. The bank said it was sticking to its “progressive and sustainable ordinary dividend policy”. In layman’s terms, that means Lloyds aims to keep increasing its dividend while keeping it at a level it can afford even if business conditions change.
The combination of a growing dividend and falling share price has pushed the dividend yield up to 4.6%. That is attractive to me and is one reason I hold Lloyds shares in my portfolio.
Could the dividend yield pass 5%?
From 4.6%, it is not a huge jump to get to a 5% yield. For example, at the moment one Lloyds share costs around 43p. But if the price falls to 40p per share or lower, the yield would reach 5%.
The Lloyds share price has stayed above 40p over the past year. But it did go down to 41p in March. I think some sudden bad news – like a grim economic report or unexpected increase in the bank’s provision for bad loans – could push the shares below 40p at some point in the next year. That could mean that the Lloyds dividend yield tops 5%.
Lloyds dividend sustainability
But the yield is not only about the share price. It also reflects the size of a company’s payout to shareholders.
I like the fact that Lloyds aims to increase its dividend and make sure it can afford to pay it from profits. But in reality, that is never guaranteed. Right now the bank is highly profitable. Not only is it paying dividends, it is also spending up to £2bn buying back its own shares. That suggests it is generating vast amounts of surplus cash.
However, banks can suffer badly during a recession. That is exactly what happened to Lloyds during the 2008 financial crisis. In fact that is when its share price fell to pennies, where it has traded ever since. If loan defaults rise, profits could tumble. That means there is a risk that the Lloyds dividend could be cut or even cancelled.
I think there is a fair chance the Lloyds dividend yield could top 5%, which I find attractive.
But I think a worsening financial outlook could spell trouble for banks. As Lloyds is the nation’s leading mortgage lender I would expect it to suffer from any increase in loan defaults. As the risks grow, I will hold my Lloyds shares for now — but have no plans to buy any more.