Lloyds (LSE:LLOY) shares have underperformed the FTSE 100 index so far this year. However, the Black Horse bank offers a higher dividend yield than the Footsie average, which potentially makes it an attractive choice for investors who prioritise dividend income.
I already have a position in Lloyds, but how many shares would I need to secure a five-figure passive income haul every year?
Let’s crunch the numbers.
Targeting £10k in dividends
Currently, Lloyds Bank offers shareholders a healthy 5.3% dividend yield, and the forward yield is around 7%. Covered by three times earnings, the bank’s dividend looks pretty safe. Usually, a coverage ratio above two is a good indicator of sustainable distributions.
On top of the juicy yield, Lloyds is undertaking a £2bn share buyback programme.
As I write, the Lloyds share price stands at 44.96p. So, to earn a £10k annual second income, I’d need 419,661 shares. That would cost me a grand total of £188,679.25.
That’s a lot to invest in one company and I don’t have that amount of spare cash to hand. Plus, there are considerable merits to diversification, which allows me to spread my investments across different dividend stocks so I’m not overly reliant on any single company.
Nonetheless, it’s a useful indication of the amount I’d need to invest in the banking group for £10k in passive income a year.
Risk and reward
Are Lloyds shares a good buy today?
Fears of a widespread banking crisis have receded following the collapse of Silicon Valley Bank and Credit Suisse earlier this year. Although financial contagion remains a possibility, I think Lloyds should be able to weather any potential storm.
It has less international exposure than other FTSE 100 banks, such as Barclays and HSBC. In addition, Lloyds is well-capitalised. Its common equity tier one ratio (a measure of solvency) of 14.1% is above its its 12.5% target.
However, tectonic shifts in interest rates could be a cause for concern. On the one hand, the bank might benefit from a boost to its net interest income. On the other, some analysts warn the UK mortgage market could face a spiral of borrowers going into arrears. This could ultimately lead to repossessions if rates climb above 6%.
That’s not an ideal scenario for Britain’s largest mortgage lender with a book worth £311bn. Not only are repossessions an expensive process, but there’s a real risk that some repossessed properties may be sold at prices that don’t cover the mortgage debt and Lloyds’ costs. This is especially true when house prices are falling, as they are today.
What I’m doing
Overall, I think Lloyds has taken sufficient steps to mitigate the risks it faces for now. It increased its bad loan provision by £243m in Q1, but profits still beat expectations.
However, I wouldn’t be surprised to see debt defaults eat into the bank’s profits if the UK enters a full-blown mortgage crisis. Although I don’t believe this would be an existential challenge for Lloyds like in 2008, it could limit share price growth.
I’ll continue to hold my Lloyds shares for the handy dividend payouts. However, to target a £10k second income, I’d rather invest in a diversified mix of dividend stocks rather than put all my eggs into one basket.
