I’m searching the FTSE 100 for the best dividend stocks to buy for my ISA. And Lloyds Banking Group (LSE:LLOY) — with its low price-to-earnings (P/E) ratio and market-beating dividend yield — seems to be just what I’m looking for.
The Black Horse Bank’s dividend yield for 2022 sits at a juicy 5.4%. This comfortably beats the FTSE index average of 3.6%.
Lloyds shares trade on a forward P/E ratio of 7.9 times, far below the UK blue-chip average of 14.5 times.
High street banks like Lloyds have long been popular stocks with income investors. Retail banking products like current accounts and credit cards are essential for any modern functioning society. This usually gives the banks stable profits and thus the means to pay reliable dividends.
But I’m not tempted to buy Lloyds shares today. Demand for its products might remain solid even as the UK economy sinks. But I think the following three factors make it a FTSE share that has too many risks.
#1: Interest rate uncertainty
First, there’s great uncertainty over the near-term direction of interest rates. And this could have a seismic bearing on the company’s profits.
Higher rates raise the difference between what banks pay to savers in interest and what they offer to borrowers. This is known as the net interest margin (NIM).
Last week, Bank of England (BoE) rate-setter Catherine Mann said that further rate rises were required to tame inflation. However, the outlook remains as clear as mud as others call for less aggressive action and even rate cuts. BoE deputy governor Huw Pill warned against the Bank doing “too much”.
The BoE may be reluctant about more aggressive tightening if recent predictions of tumbling inflation prove correct. Citigroup, for instance, has predicted that consumer price inflation (CPI) will fall to 2% by the end of 2022. This will put the gauge well within policymakers’ target range.
#2: Rising impairments
Lloyds faces a steady escalation in bad loans as consumers and businesses feel the pinch. The business clocked up £1.5bn worth of loan impairments in 2022, including impairments worth £500m during the fourth quarter alone.
These costs caused underlying profit to fall 1% year on year, to £7.5bn. And they offset the 18% jump in underlying net interest income (to £13.2bn) that was driven by higher interest rates.
Lloyds is especially at risk from a surge in mortgage defaults as interest rates likely climb further in the first half and high inflation endures. The bank is the UK’s biggest home loan lender with a market share of around 20%.
The Office for National Statistics estimates that 1.4m households whose fixed-rate deals expire this year face higher rates. A crunch could be coming.
The bottom line
As I say, the Lloyds share price looks cheap. But there are many FTSE 100 companies with low valuations that I can buy for my investment portfolio today. So why should I take a chance with this particular stock?
Given the threats mentioned above — as well as the longer-term problem of intensifying competition — I’d rather invest in other dividend shares right now.
