Could the Lloyds dividend survive a housing market crash?

One of the attractions for me is to have a stake in it Lloyds (LSE: LLOY) is an income potential. As a big bank, it has been shown to be hugely profitable.

Last year, for example, after-tax profits came in at more than £100m a week. As a customer who has suffered from high transaction fees and branch closures, I can’t say I like the bank’s strategy.

But, clearly, it can be very profitable. Lloyds’ annual dividend has recently increased by around 20%. The stock currently yields 4.7%.

But how safe are those dividends, say if the housing market really starts to struggle? After all, Lloyds is the country’s biggest mortgage lender.

Default risk

History can help us here – but not completely. During the financial crisis, Lloyds cut its dividend and it took years to recover. Even today, it is far below the level it used to be. It’s another reminder, as needed, of how much banks can be affected by a tough economy.

People start paying off their debts at the same time, property values ​​go down. So banks can be left unpaid while holding lower assets than before. That’s what happened to Lloyds – and most of its rivals – during the financial crisis.

But while the underlying pattern is unlikely to change, it is worth noting that Lloyds today is not the same bank in 2008. The bank has tightened risk control since then. So whenever the next housing market crash comes, Lloyds should be more prepared than the last time around.

A gathering storm

Lloyds has taken pains to share its asset quality and default rate over the past few quarters.

However, looking at the annual results published last month, there was an underlying disruption charge of £1.5bn. The previous year, the number was a credit, although it partly reflects the unpredictable economic environment in the pandemic era.

But clearly, the cost of £1.5bn disruption is considerable. Indeed, this is part of the reason why the bank’s statutory profit after tax fell by 6% compared to the previous year. It remains huge. But if the cost of impairment this year increases again, it may weaken the profit.

Lloyds dividend coverage

In some ways that may not matter too much for Dividend Lloyds. Of the £5.6bn post-tax profit, only around £1.6bn will be used to pay dividends. So even after a big increase in pay, comfortably covered by earnings.

In fact, one of the reasons I sold Lloyds shares last year was because I felt the management were not distributing as much profit as I would have liked in the form of dividends. Lloyds’ dividend is still below 2019 levels.

Be careful not to give a real pillow size though. Even if profits fall sharply, they may be large enough to support dividends at current levels.

However, if the crash causes enough debt to fail, the dividend may not be sustainable. In a crash, banks can also be ordered by regulators to suspend dividends. Lloyds has done so twice this century. There are no guaranteed dividends – including at Lloyds.