The Return of Bank Dividends

The largest U.S. banks are currently going through another round of “stress tests” in order to prove to the Federal Reserve that they can withstand another financial crisis. Of course, this test comes seven years after it was truly needed. The test results will be made known on March 20 and March 26.

The immediate effect for investors is that some of these banks will get the green light to raise their dividends and increase share buybacks. Citigroup and Bank of America, for example, only pay out one penny per quarter. Citi is expected to earn nearly $5 per share this year, and BAC is projected to make $1.32 per share. In 2011, BAC asked the Fed if they could do a modest dividend increase. The Fed said no.

The truth is that nowadays these banks are quite profitable. Of course, we don’t know which banks could fail the test. The largest banks will most certainly pass, but this test includes some smaller ones and I’m sure someone will be left out. I suspect Citigroup will jack up its dividend soon, but that will also be complicated by a recent $400 million fraud decision. The unknown legal bills will weigh on several other banks as well.

The six largest U.S. banks may return $47.8 billion starting in April, the estimates show. That compares with $23.6 billion for the prior year, according to Stifel Financial Corp.’s KBW unit. The firms gave back $66.4 billion in the 2007 calendar year, data compiled by Bloomberg show.

“The dividends and buybacks — the sheer size of them — suggest there is plenty of profit to play with,” David Ellison, a Boston-based mutual-fund manager specializing in financial stocks at Hennessy Advisors Inc., said in a phone interview. “It shows that if a bank is run appropriately, it’s very profitable.”

I’ve told investors that in light of the uncertainty, the best way to value these banks is by the dividend yield (though that’s not the only way). The issue is that many of the other traditional valuation metrics don’t work well with the big banks.

I would be very careful about committing any funds to financials right now. It’s not that there’s long-term danger, but whoever fails the test will surely be punished by the market.

Posted by on March 17th, 2014 at 2:24 pm


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