Banking giant Lloyds (LSE:LLOY) has traditionally been one of the most popular shares among UK investors. This is thanks in large part to its reputation as a rock-solid passive income stock.
Yet the FTSE 100 company has fallen well down the charts in recent months. Despite the prospect of more market-beating dividends, investors have still turned away from the bank in substantial numbers.
As the table below shows, City analysts expect cash rewards on Lloyds shares to keep rising, meaning the dividend yield remains well above the FTSE average (of 3.6%) over the short term.
| Year | Dividend per share | Dividend growth | Dividend yield |
|---|---|---|---|
| 2025 | 3.43p | 5% | 5.6% |
| 2026 | 4.01p | 17% | 6.5% |
However, it’s important to remember that dividends are never, ever guaranteed. And over the next couple of years the bank faces a significant threat that could deliver a hammerblow to dividends.
So how realistic are these dividend estimates for Lloyds, and should I buy its shares for passive income?
Strong measures
The first thing to consider when assessing any dividend share is how well predicted dividends are covered by anticipated earnings. A figure of two times or above provides a wide margin of error in case profits come in below forecast.
On this front the Black Horse Bank scores well. For 2025 and 2026, dividend cover comes in at 2 times and 2.2 times respectively.
The next factor to look at is balance sheet strength. For banks, a good gauge of this is the common equity tier 1 (CET1) ratio. On this front Lloyds also looks good.
As of September, its capital ratio came in at 13.6%, a comfortable distance above capital requirements.
Cost uncertainty
So far so good, then. But while these standard measures are encouraging, there’s another important thing to consider in the case of Lloyds: the potential for whopping misconduct charges, this time over the issue of mis-selling car finance.
The FTSE firm had, in early 2024, set aside £450m to cover potential costs. But it put this amount under review in October, after the Court of Appeal ruled that undisclosed fees from finance providers to car retailers was unlawful.
The banks have received better news on this in recent hours, however. To avoid a meltdown in the car loans market, the Treasury has said it will express concerns over potential sector costs to the Supreme Court when it reviews the case.
But right now the risk of whopping costs related to the Financial Conduct Authority (FCA) probe remains significant. Morgan Stanley estimates this could total £30bn, while HSBC puts it at an even-higher £44bn.
As the sector’s largest player, Lloyds could be on the hook for a whopping share of any hit.
Here’s where I stand
For this reason, I’m happy to leave Lloyds shares on the shelf today. As well as impacting future dividends, a colossal mis-selling bill could also crash the bank’s share price.
Signs of recovery in the housing market are great news for the Black Horse Bank more recently. But on balance, things remain pretty bleak for the bank as the UK economy struggles and more misconduct costs loom large.
On balance, I’d rather find other high-yield dividend stocks to buy.
This post was originally published on Motley Fool
