When Will Banks Start Paying Dividends Again?

Not long ago, banks were regarded like utilities: safe companies that paid consistently huge dividends. It wasn't uncommon for yields on bank stocks to reach 5% or 6%, with increases year after year. They were like bonds, but turbocharged.

Then 2008 happened. Most banks all but eliminated dividends as capital disappeared. In Feb. 2009, the Federal Reserve politely reminded banks clinging to their payouts that "board of directors should strongly consider … reducing, deferring, or eliminating dividends when the quantity and quality of the [bank's] earnings have declined." Just in case they forgot.

But that was then. One year, a stronger economy, and a mess of bailouts later, bank investors eagerly await the return of dividend normality. Investors' curiosity ramped up last week, when JPMorgan Chase (NYSE: JPM  ) CEO Jamie Dimon wrote to shareholders that he hopes "to be able to increase the dividend to an annual range of $0.75 to $1.00 per share."

Hope, though, is different than reality. Before normal dividend payouts can resume, we have to answer two questions: Can banks afford it? And even if they can, will they truly want to pay dividends?

Step one: Can they pay?
Banks consider two factors when deciding whether they can afford to pay dividends: capital adequacy and earnings.

Things look great on the capital front. After raising piles of equity in 2009, the four largest deposit-taking banks are now as fortified as they've been in years:  

Bank

Tier 1 Capital,
Dec. 31 2009

Average Tier 1 Capital,
2004-2008

JPMorgan Chase

11.1%

9.0%

Citigroup (NYSE: C  ) ,

11.7%

9.0%

Bank of America (NYSE: BAC  )

10.4%

8.2%

Wells Fargo (NYSE: WFC  )

9.3%

8.2%

Source: Capital IQ, a division of Standard & Poor's.

Anything greater than 6% Tier 1 capital is considered "well-capitalized" by most standards, so these banks enjoy a fairly thick buffer. We could further discuss things like tangible equity and liquidity pools, but the depth of Tier 1 capital alone makes it hard to argue that large banks are undercapitalized (provided you trust the elusive world of bank accounting rules, of course).  

Earnings are another story. Despite recent impressive profits, banks' good news has been invariably associated with fixed-income trading that simply isn't sustainable. Core commercial banking operations at the 100 largest banks remain awful, as 30-day-plus delinquency rates reveal:

Segment

Q4 2009

Q3 2009

Q2 2009

Q1 2009

Residential Mortgage

11.21%

10.70% 

9.65%

8.74%

Commercial Mortgage

9.56%

9.41%

8.12%

6.53%

Credit Cards

6.44%

6.62%

6.78%

6.64%

Commercial/Industrial

4.54%

4.51%

3.77%

3.11%

Agricultural Loans

7.50%

5.32%

4.08%

2.67%

Source: Federal Reserve.

Delinquencies are still increasing in most segments, and what little improvement we've seen is trivial at best. That trend needs to change before anyone can become sensibly excited about banks' ability to earn real money.  

Some investors -- usually those with money on the line -- insist this turn is right around the corner. Maybe they're right. But they've been chanting this unrelentingly for nearly three years now. Looking at basic metrics like price-to-income for housing, and unemployment for credit cards, makes it easy to envision loan losses remaining in the dumps for another year or two. Earnings might not fare much better.

But let's assume, for bullishness's sake, that earnings make a quick turnaround. You still shouldn't expect dividends to automatically follow.

Step 2: Will they pay?
Even if banks are making all the money in the world, they'll be loath to part with their cash if Congress keeps busily changing the rules of the game. That's exactly what's happening right now -- as it should.   

With health-care reform now complete (thank goodness), financial regulatory reform is next on the neverending congressional list of long-overdue things to do.

Specifics of any reform are torn along party lines (shocker), but anyone awake over the past two years knows that at a minimum, reform should include:

  • Increased capital standards.
  • Increased liquidity standards.
  • Limitations on derivatives (which, in turn, can increase capital standards).

Any degree of reforms like these will impede banks' ability to pay dividends. And the steps above represent a bare minimum. Reform with a backbone would include breaking up too-big-to-fail banks, outlawing wide swaths of the derivatives market, and completely eliminating the trading segments commercial banks have come to rely on.

Even if proposed reform is minor, banks likely won't make major dividend decisions until reform is signed, sealed, and delivered to the president's desk. And if you've followed Congress's vitriolic rhetoric and peerless ability to get absolutely nothing done, that day could be a long way off -- easily (and intentionally) after the November elections.

Don't hold your breath
I wouldn't be surprised to see big banks increasing dividends at small symbolic rates, just for the headline effect. But the days of dividend glory still seem distant. If you're searching for yield, stick with proven players such as AT&T (NYSE: T  ) , Altria (NYSE: MO  ) , and Pepsi (NYSE: PEP  ) . Banks' rebound from the depths of 2009 doesn't mean they're on track to revisit the joys of 2006.

Check back every Tuesday and Friday for Morgan Housel's columns.

Fool contributor Morgan Housel owns shares of Altria. PepsiCo is a Motley Fool Income Investor recommendation. Motley Fool Options has recommended a "roll your diagonal call" position on PepsiCo. The Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (45)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 06, 2010, at 5:13 PM, GeneralwStars wrote:

    Jamie, don't step so timidly. Either buy earning assets or pay your shareholders.

  • Report this Comment On April 06, 2010, at 6:23 PM, sheriden101 wrote:

    "With health-care reform now complete (thank goodness),"

    Wait.....does this mean you are in favor of this reform?

  • Report this Comment On April 06, 2010, at 7:05 PM, jm7700229 wrote:

    "With health-care reform now complete (thank goodness)." Are you joking? Congress hasn't even identified any of the myriad the problems with their "reform" yet, let alone completed it. This will be a major source of funding (from the gazillion new lobbies created) for Congresspeople, not to mention lawyers, for years and years to come.

  • Report this Comment On April 06, 2010, at 7:19 PM, rgif102478 wrote:

    Banks seens to be able to do just what they Want.

    One big reason they will not loan money is because

    they will waite and see, what banke will go under and

    then they will jump in and buy them out for twenty

    cents on the dollar.

    The US should have let them all go under. Bob Gifford

  • Report this Comment On April 06, 2010, at 7:45 PM, lakespapa1 wrote:

    "With health-care reform . . ." Wow, three comments, and two of them pick up on this line to complain about. Weird (not).

    At any rate, whole bunch of self-employed people are breathing a sigh of relief over this bill -- also, a whole bunch of employees of small business are breathing a sigh of relief. A lot of insurance companies are, too, because now they know what to expect (and got a lot of what they wanted).

    Are there bad things in the bill? Yup. And a lot of good things. And none of it's going to lead to Leningrad in America.

  • Report this Comment On April 06, 2010, at 10:30 PM, robertf36009 wrote:

    Health care aside banks paid dividends before derivatives were invented. While IMHO derivatives should be banned I don't see that they would affect dividends in their absence . Banks paid dividends when they were subject to Glass/Steagall and IMHO that law should be reinstated. In fact about the only reason to own bank stocks under normal conditions would be dividend compounding. Face it historically banks have not exhibited blistering growth and until recently were usually thought of as a little stodgy.

  • Report this Comment On April 07, 2010, at 3:11 AM, RRGGBB wrote:

    I think all bonuses should be eliminated and used to pay dividends. As stock holders we trusted a team that needs to be punished - not us the shareholder.

  • Report this Comment On April 07, 2010, at 11:59 AM, DJDynamicNC wrote:

    Just about right, in my view. Banks are going to wait for the (much needed) reforms Congress is working on before committing to large payouts of dividends.

    On top of that, the commercial real estate market is still teetering on the brink - this could still lead to major damage to the financials.

  • Report this Comment On April 07, 2010, at 12:06 PM, Gorm wrote:

    This is unlike banking of yesterday!

    Banks are expected (by analysts) to be high EPS performers, ever improving gains.

    It has been proven within the industry, and affirmed by Greenspan, size affords little in expected economies of scale, shareholder benefit.

    So, if bigger doesn't get your more EPS, then breadth, ie penetration into insurance, brokerage, mortgage. Well, that has not worked.

    So, lets take on more risk as that affords more opportunity for material gain. We privatize the gains and socialize the losses.

    Bottom line, banks can't be the same and different. At least for the Big Boys there is NO going back!

  • Report this Comment On April 07, 2010, at 2:13 PM, plange01 wrote:

    the banks that are left after this depression ends in a few years will slowly start to pay dividends again...no time soon for sure....

  • Report this Comment On April 08, 2010, at 3:08 PM, Beanfarmer wrote:

    Stupid question, the bank I work for never stopped paying dividends.

  • Report this Comment On April 08, 2010, at 3:08 PM, Beanfarmer wrote:

    ... and didn't reduce them either.

  • Report this Comment On April 11, 2010, at 12:35 PM, multi007 wrote:

    Here's the way Id finish the line "With health care reform finsihed..."

    ...the Republicans will be the supermajority and will hence have the ability to reverse Universal Heal Care.

    ...the soon to be realized costs of Health Care Reform will cause a double dip recession (thus causing the above mentioned supermajority to be a gaurentee)

    ...even the Republicans arent perfect. And with that said, a Republican supermajority can do just as much harm to the USA as the Democrat super-majority has, except cheaper.

    ...when the Republicans become the super majority, there will be drastic cuts to government, welfare and overall spending. This will cause bank's earnigns to be depreciated as well.

    (of course this is just one man's opinion)

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1144484, ~/Articles/ArticleHandler.aspx, 9/1/2014 3:25:12 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement