Last month, Lloyds (LSE: LLOY) raised its annual dividend by around 20%. The bank’s dividend yield is now over 5%, which for a FTSE 100 share like this I find attractive.
But might the dividend increases keep coming at the same level? After all, Lloyds is generating plenty of spare cash and the dividend is amply covered. It has not even returned yet to its pre-pandemic level.
If the Lloyds dividend keeps rising at its current rate, then after a decade it would be almost 15p per share (still, by the way, way less than half of what it was before the 2007 financial crisis). With Lloyds shares currently selling for less than 50p each, that would mean my prospective yield today would be 31%, making the shares a long-term goldmine.
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Could that really happen – and should I buy?
Lloyds dividend forecast
In principle, I do think it could. Lloyds is hugely profitable and I expect it to remain so. It benefits from robust demand for financial services, well-known brands and a large customer base. Indeed, it is the country’s largest mortgage lender.
On the other hand, for the dividend to keep rising at its current level requires management willingness and financial capability.
I already have a doubt about management’s commitment to plough ever-larger sums into paying the dividend. Yes, this year’s increase was substantial. But it still leaves the payout well short of what it was before banks were compelled to suspend their dividends during the pandemic. That is despite the fact that Lloyds is currently rolling in cash, to the point it is spending £2bn at the moment buying back its own shares.
What about financial capability? Buying back those shares and cancelling them will mean fewer shares in circulation, which if profits are maintained should boost earnings per share. The Lloyds dividend is already amply covered by earnings. Last year, the payout was 2.4p per share, less than a third of the bank’s 7.3p of basic earnings per share.
But can earnings continue at their current level?
Financial storm clouds
I have my doubts. The bank has repeatedly stressed that the quality of its loan book remains high and defaults are low. But in an environment of high inflation and rising interest rates, there is a real possibility that the default rate will rise. Throw in the prospect of a property market slowdown, or crash, and I think the prospect of higher default rates increases.
I see that as a risk in the current environment and the recent run of bank problems in the US and Switzerland has made me more nervous. Lloyds has a better capital buffer now than it did in 2007. However, banking crises are about confidence not just financial reality. If one UK financial institution sneezes, I am concerned that all British banks may catch a cold.
In such a situation, I do not merely expect the Lloyds dividend to increase at a slower rate than now. I see a possibility it could be stopped altogether if there is a full-blown financial crisis at some point in the coming decade. I have no plans to add the shares (or any banking shares) to my portfolio.
