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Bank dividends on the rise?

Financials are in relatively good condition and could grow their dividends.

  • Financials Sector
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In the aftermath of the 2008 financial crisis, U.S. banks have faced tighter regulations as the federal government sought to minimize systemic risk in the sector. In particular, banks were required to build capital, and increase reserves to higher levels. As a result, surviving banks have come out of the crisis with much stronger balance sheets, and collectively have the least amount of outstanding debt since the 1940s.

More specifically, for commercial banks whose deposits are insured by the Federal Deposit Insurance Corporation (FDIC), the average equity/assets ratio was 11.1% in 2012, significantly higher than 9.38% in 2008, and the group’s 7.5% historical average (see the chart right).

Banks are once again earning above-average returns that are higher than the group’s long-term average, and closer to pre-crisis levels. In 2012, banks’ average return on assets (ROA) was 1%, compared to the historical average of 0.8% (see the chart below).

Banks are positioned to grow dividends

Most U.S. banks are now at or above the adjusted minimum capital levels required by regulators. However, bank dividend payout ratios are around 24% of earnings, on average, well below the historical average of 46%. With stronger bank balance sheets, improved profitability, and limited investment opportunities, banks are well positioned to increase capital return to investors. Some banks may also choose to retain capital for acquisitions.

Ultimately, any capital return proposed by large-cap banks will be subject to the Fed’s annual stress test—officially known as the Comprehensive Capital Analysis and Review (CCAR), and the finalization of minimum capital requirements, which regulators continue to discuss. In early July, federal regulators proposed a plan to increase the leverage ratio, which measures U.S. capital as a flat percentage of assets, on the eight largest bank holding companies. Smaller banks will remain subject to overall standard regulatory requirements.

State of the financials sector

See why valuations remain attractively low on a price-to-book-value basis vs. the S&P 500.

Read the article

In the current environment of low interest rates, investors have bid up the stock prices of higher-yielding equities. Relative valuations for high-dividend-paying industries, such as utilities and telecommunication services, have expanded.1 At the same time, the historically higher-yielding banks have not fully participated in this search for dividend yields, as the average price-to-earnings multiple of S&P 500 banks remains depressed (see the chart below).

As the payout ratios of banks return to pre-crisis levels, bank stocks have the potential for upward revaluation. Going forward, bank stocks thus could offer a desirable stream of dividend income in addition to capital appreciation.

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Quantitative easing (QE): Unconventional monetary policy used by central banks to stimulate the economy. Typically involves the purchase of financial assets from commercial banks or private institutions, which increases the monetary base.
Equity/assets ratio: A financial metric used to ascertain a company’s financial stability. The equity-to assets ratio is the value of the corporation’s equity divided by the value of its assets. Equity represents the total current value of the money invested in the corporation by all its shareholders— the cumulative value of all its shares—in addition to any retained earnings generated by its operations. Assets represent the entire value of the corporation, such as its equity, its inventory, its accounts receivable, and any revenue generated from loans. A high ratio means that the corporation is mostly owned by its shareholders, while a low ratio means that the corporation is likely burdened with high debt.
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1. Source: Haver Analytics, Fidelity Investments as of June 14, 2013.
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