The Lloyds Banking Group (LSE:LLOY) share price continues to sink. In fact the FTSE 100 bank has just dropped to seven-month lows as worries over a potential recession intensify.
Profits at retail banks are very sensitive to broader economic conditions. So the growing threat of a recession as interest rates rise is spooking investors. But as a value investor I’m giving Lloyds shares another look.
They now trade on a forward price-to-earnings (P/E) ratio of just 5.6 times. The bank also carries huge dividend yields of 6.5% and 7.2% for 2023 and 2024, respectively.
I’m looking to boost my passive income and so those dividend yields look particularly tempting. They suggest that £10,000 invested in the bank today could make me passive income of £650 this year and £720 in 2024.
But just how strong are these dividend forecasts in the current economic climate? And should I buy cheap Lloyds shares for my portfolio today?
Robust forecasts… for now
Last year the company paid a total dividend of 2.4p per share, up 20% year on year. City brokers are tipping another healthy payout increase in 2023, to 2.8p. And a 3.1p dividend is forecast for next year as well.
Current earnings forecasts suggest there’s a great chance of these dividend estimates hitting their mark. Dividend cover sits at 2.6 to 2.7 times for the next two years, comfortably above the safety watermark of 2 times and above.
Lloyds also has a strong balance sheet that could potentially help it fund those big dividends. Its CET1 capital ratio stood at 14.1% as of March. This was ahead of its target of 12.5% plus a management buffer of 1%.
Huge dangers
But of course it’s hard to ignore the huge shadow that Britain’s flagging economy casts over these projections. As the UK flirts with recession current earnings and dividend estimates could be subject to large downgrades.
On the one hand, higher interest rates are good for banks. Their net interest margin (NIM) — which measure the difference between borrowing and savings rates — could have much further to climb as the Bank of England gets more aggressive with policy tightening.
Current consensus suggests rates will peak at 6% by next spring, up from 5% at present. However, any boost to NIMs threatens to be offset by stagnating loan growth and soaring impairments as higher rates choke the economy.
Lloyds’ performance in 2022 illustrates the danger. Although its NIM rose 40 basis points to 2.94%, pre-tax profit still sank 6% year on year to £5.6bn as bad loans rocketed.
Impairments of £1.5bn last year continued to grow during the first quarter of 2023. And they threaten to explode well in the coming months. Lloyds is especially exposed given its position as Britain’s biggest home loans provider.
I believe the chances are high that dividends here could disappoint in the next two years. I also reckon that Lloyds’ share price could continue to collapse. Right now I’d much find other FTSE 100 dividend stocks to buy.
