Investing in FTSE 100 retail banks has long been a popular idea for those seeking dividend income. Lloyds Banking Group (LSE:LLOY) shares remain in high demand even as the UK economy toils.
The modern world cannot operate without products like current accounts, credit cards and loans. So while companies like Lloyds offer little in the way of earnings growth, their essential role makes them a reliable destination for dividend income.
6.3% dividend yield
In fact, current dividend forecasts suggest Lloyds could be one of the best FTSE 100 dividend payers over the medium term.
City analysts expect last year’s 2.4p per share total dividend to rise to 2.8p in 2023. It’s expected to raise rewards to 3.1p in 2024 too. This means that forward dividend yields sit at 5.7% and 6.3%, far above the FTSE 100’s 3.5% forward average.
These predicted dividends look pretty realistic as well. They’re covered between 2.6 times and 2.7 times by anticipated earnings, a range that provides a wide margin of safety.
Even if profits disappoint over the next two years, the strength of the bank’s balance sheet means it could still hit these dividend forecasts. Lloyds’ CET1 capital ratio stood at 14.1% at the end of 2022, well ahead of its 12.5% target.
However…
City brokers might be bullish about Lloyds’ dividend prospects. But I still have big concerns about spending my own cash on The Black Horse Bank right now.
Analysts expect the business to grow earnings by mid-to-high single-digits over the next two years. But the immense difficulties facing the UK economy could make this a tough achievement.
In this environment Lloyds could struggle to grow earnings at all. And by extension its share price could stagnate or even reverse, offsetting the boost of its big dividend yields.
Why I’m avoiding Lloyds shares
To repeat my earlier point, retail banking is an essential service and demand for financial products remains largely robust even in tough times. Yet companies like Lloyds aren’t considered safe-haven shares as loan defaults can soar, pulling profits lower.
Lloyds chalked up £1.5bn worth of impairments in 2022. And as a consequence its pre-tax profits flatlined around £6.9bn.
Its earnings forecasts also reflect expectations that interest rates will keep rising. Higher rates boost the profits that banks make on their lending activities.
However, the outlook for interest rates remains as clear as mud. In fact, many economists believe the Bank of England (BoE) could stop raising rates soon and slash them towards the end of the year as inflation falls.
Former BoE chief economist Andy Haldane told Sky News over the weekend that inflation could topple as low as 3% during the next six months. The implications of this could be devastating for profits at businesses like Lloyds and leave earnings estimates in tatters.
On balance, investing in Lloyds shares isn’t attractive enough for me right now. I’d much rather buy other FTSE 100 shares to boost my passive income.
