3 Bank Stocks That Could Raise Their Dividends

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In the past, banks were seen as a solid source of dividend income. Banks could pay out a small percentage of their income and retain the rest to grow their loan books, and thus their future earnings. Although a lot has changed -- big banks now need approval from the Fed to issue dividends to investors -- some banks including Bank of Hawaii (BOH -3.08%), Citigroup (C -2.63%), and PNC Financial Services Group (PNC -2.02%) could soon offer their investors bigger dividend paydays.

An island banker

Bank of Hawaii recently increased its quarterly dividend from $0.45 to $0.48 per share, but future dividend hikes could be in the cards. The company benefits from the fact that it competes in the remote islands of Hawaii, which has become a duopoly market as the bank and its closest competitor together have more than 68% of the state's deposits.

Limited competition allows Bank of Hawaii to pay less on its deposits and earn outsized returns on its equity. The company has also proven to be a capable underwriter, and conservative in its estimates for future loan losses. The company currently maintains an allowance for loan and lease losses of 1.25% of loans outstanding. Meanwhile, only 0.2% of its loans were non-performing at the end of the second quarter.

Bank of Hawaii has historically paid out a substantial portion of its earnings in the form of dividends and repurchases. In the last 12 months the bank paid out $79 million of dividends, and repurchased $66 million of stock, equating to about 84% of its net income during the period. After its first dividend increase since the financial crisis, Bank of Hawaii may be signaling that it sees the potential for increased dividends going forward.

A "Big Four" bank

After failing the Fed's stress tests twice, Citigroup passed with flying colors in 2016, getting approval to increase its quarterly dividend from $0.05 per share to $0.16 per share. Despite a tripling of the dividend, the company has plenty of capacity to increase its payouts upon approval from the Fed each year.

Consider first that the company's dividend payout ratio is relatively low. At $0.64 per share, per year, Citi's payout ratio sits at about 13% of its earnings over the last 12 months. As my colleague John Maxfield explained, the Federal Reserve indicated in 2011 that it would not approve dividends that pushed payout ratios above 30%. Recently, however, the Fed has allowed well-capitalized big banks to pay out more than that 30% limit.

If Citigroup's payout were to rise to just 30% of trailing twelve-month earnings, it could increase its quarterly dividend to as much as $0.375 per share, more than twice what it currently pays out to shareholders.

Citigroup isn't without its challenges and historical missteps, having suffered dramatic losses during the financial crisis, and poor share-price performance ever since. But the market largely reflects this reality, allowing shares to trade at about 73% of its second-quarter tangible book value, the lowest valuation of any Big Four U.S. bank.

A sturdy Super Regional bank

PNC Financial has rewarded investors with substantial dividend increases since slashing its dividend during the financial crisis, recently increasing its quarterly dividend from $0.51 per share to $0.55 per share. The increased dividend is equivalent to a 30% payout ratio on its trailing twelve-month earnings, suggesting some breathing room for dividend increases going forward.

PNC Financial has managed its balance sheet very conservatively -- perhaps too conservatively. The company holds about $26 billion of capital (more than 10% of its customer deposits) at the Federal Reserve, earning little more than 0.50% per year. The thesis goes that if this cash were redeployed into higher-yielding securities or loans, PNC Financial's net interest income would jump immediately. PNC executives, however, have indicated that they won't rush to move the capital, choosing to be prudent about when and how to put the money to work.

Credit quality at PNC has been good, and charge-offs minimal. The bank last reported its nonperforming loans stood at just 1.08% of total loans, and its net charge-offs were just 0.17% and 0.44% of commercial and consumer loans, respectively, in the most recent quarter.

Even with currently tepid loan growth, PNC Financial has capacity to increase its dividend. But its excess deposits present the opportunity for PNC Financial to increase its profitability markedly in a step function, by moving them from a low-yielding account at the Fed to higher-yielding loans to households and businesses.