Buy cut-price bank stocks for passive income? Yields do look chunky after interest rate rises. And with the latest projections expecting elevated borrowing costs to stick around, banking might be a promising sector for income hunters.
Lloyds (LSE: LLOY) in particular looks like a cheap buy to me. The shares have tumbled to 43p. The dividend has climbed to levels not seen since the heady banking era of pre-2008. And the bank just posted record earnings.
Let’s say I wanted a £100 monthly passive income. We’ll call it £1,200 from the two dividends that Lloyds pays each year.
At the current share price, I’d need to buy 38,095 shares.
In cash
In cash terms, I’d be shelling out £16,381 to the nearest pound. That sounds pretty enticing for an extra £100 each and every month, although the real question is how reliable it is going forward.
My current estimate is based on the forward yield of 7.14%. The consensus across 15 City analysts forecasts a rise to 7.84% and then 9.33% in the two fiscal years following that.
A rising payout is what I want to see from dividend stocks. My Lloyds shares would give me more passive income each year even if I don’t reinvest the dividends.
So what’s the catch? Well, it might be interest rates. They’re high now which means big margins for banks and consequently bumper dividends, but what about in 3, 5, or 10 years?
Low rates?
Well, the Bank of England doesn’t plan so far ahead but its latest report (from December 2023) expects rates to still be at 4.25% by the end of 2026.
And UK 10-year gilts are currently at 4.02%. this implies another decade where rates are unlikely to return to the near-zero levels we used to have.
Despite this, Lloyds trades at less than five times earnings. It seems like the market has the bank cheaper than when interest rates were 0%.
Anyone buying the shares today might be able to enjoy a happy combination of a strong dividend and an undervalued share price.
Firing line
There are risks, of course. Lloyds brings in almost all revenue domestically and the country just slipped into a ‘technical recession’.
Likewise, higher rates mean more loan defaults. Impairments actually fell in the bank’s latest updates but we might still be early on in this period of expensive loans and borrowing.
If either issue was to seriously affect earnings then the highest dividends for 15 years would likely be in the firing line.
On balance though, Lloyds shares look cheap to me. I own the shares for passive income already and I’m impressed with a yield forecast to reach 9% in the years ahead. I’d consider buying more if I had the spare cash.
