Income investors have a long-running love affair with British banks like Lloyds Banking Group (LSE:LLOY). Even as the UK economy toils, this FTSE 100 stock remains extremely popular with individuals seeking dividend shares.
Banking businesses are renowned for their stable and reliable earnings. Products like current accounts, general insurance and credit cards provide them with a steady stream of income. UK banks are also well regulated by the Financial Conduct Authority (FCA), which provides an extra layer of security for investors.
Lloyds is seen as especially robust following significant de-risking after the 2008 financial crisis. The sale of its investment bank and subsequent focus on retail banking means profits tend to be more stable than those of Barclays and HSBC, for instance.
Dividends to grow?
Such predictability means City analysts expect the bank’s dividends to continue rising even as the domestic economy toils.
Last year’s 2.4p per share total reward is tipped to improve to 2.8p in 2023 and then to 3.1p next year. These forecasts are supported by predicted earnings rises of 2% in each of these years.
Consequently the dividend yield on Lloyds shares sits at a gigantic 6.8% and 7.5% for 2023 and 2024 respectively. Both figures sail past the forward FTSE 100 average of 3.8%.
On paper, The Black Horse Bank looks in great shape to meet these estimates as well. Predicted dividends are covered around 2.5 times through to the end of next year, above the widely regarded minimum safety benchmark of 2 times.
While things can change, the company’s strong balance sheet also provides further confidence that these payout targets can be reached. Its CET1 capital ratio stood at 14.2% at the mid-point of 2023.
The dangers
Yet despite all this, I’m not prepared to buy Lloyds shares for my own portfolio today.
There’s a good chance that it will pay the forecast dividend for this year. But as trading conditions at home worsen, I believe current payout projections beyond 2023 are in danger.
As I suggested, many products that retail banks provide are essential at all points of the economic cycle. But demand in key areas like mortgages — an especially important market for Lloyds — could sink as interest rates rise and the cost-of-living crisis endures.
Of course banks also face mounting credit impairments as people and businesses struggle to make ends meet. This particular FTSE bank put away another £662m to cover bad loans in the first half of 2023, taking the total since the start of last year to a stunning £2bn.
I’m also concerned about a recent reduction in Lloyds’ capital ratio. Its CET1 metric remained above the firm’s target “of c.12.5%, plus a management buffer of c.1%” in June. But this was down almost 1% from the end of last year.
The bottom line
My fears for Lloyds’ earnings extend beyond the next couple of years. Unlike Barclays and HSBC, it doesn’t have an investment bank or exposure to foreign markets to give earnings a boost.
At the same time, Lloyds’ profits are being damaged by growing competition in the banking sector. And these could affect dividend growth over the longer term.
On balance, I’d much rather find other dividend stocks to buy today.
