I’m buying Lloyds shares for the juicy 6.25% forward yield!

Lloyds (LSE: LLOY) Shares are not always the most exciting FTSE 100. It is a British bank with a low appetite for risk. In fact, Sir Antonio Horta-Osorio was knighted for his efforts to make the institution more stable and reduce exposure to risky operations.

So why am I buying more Lloyds shares? Let’s take a closer look.

Improve results

Today, Lloyds pays a dividend of 4.2%. That’s above the average index, and I’m quite satisfied with it.

However, City analysts are predicting a full-year dividend of 2.4p in 2022, rising to 2.7p and 3p in 2023 and 2024. The 2024 figure represents a 25% rise from the current position.

The dividend yield in 2024 is 6.25 %. For me, that is very attractive, especially from the company will have a relatively low risk profile.

This increased dividend payment may be affordable. The highest value of the stock in 2021 is 3.8 Euros. That means earnings can cover dividends 3.8 times. Usually, the above two results are considered healthy.

Interest rate sensitivity

Lloyds does not have an investment arm and due to the composition of its funding, it has a higher interest rate sensitivity than other banks.

This has not been the case over the past decade, as rates have been near zero. But now rates are increasing and net interest margin (NIM) is increasing. The bank said that NIM is forecast to reach 2.9% by the end of 2022, and may grow again in 2023.

Moreover, this can be a tailwind that lasts for some time. After all, mortgages are often fixed and customers who take out mortgages now will be stuck with higher rates for longer. Hedging strategies can also help extend these benefits.

About 70% of the bank’s income comes from UK mortgages. Thus, changes in NIM have a disproportionate impact on earnings. In some respects, this reliance on UK mortgages is inappropriate. However, traditionally, this is a fixed market area.

It is also worth noting that Lloyds even gets more interest on deposits with the central bank. Analysts suggest that each increase of 25 basis points is worth £200m in interest revenue.

The stock price is discounted

Lloyds has been trading at a discount for some time. In fact, some discounted cash flow models show that the stock could be undervalued by as much as 55%. However, of course, the model relies on cash flow forecasts, and these can be difficult to predict.

Discounts can, and probably do, reflect concerns about the UK economy in the near term. The nation has avoided recession this time, but the forecast for 2023 is fairly flat. Many analysts still expect a recession.

Banks feel the recession especially hard. When the economy turns upside down, debt turns bad. And banks have to respond by setting aside more money. In Q3, impairment charges rose to £668m from a release of £119m a year earlier as bad debt concerns intensified.

Hopefully, not all the money will be needed. And it’s not that I’m discounting the impact of bad debt, but I do believe that higher interest rates will result in greater returns in the coming years.