Next Up for Banks: Dividends?

OK, so technically most of the big banks are still dividend-paying stocks. Citigroup's (NYSE: C  ) payout may still be a goose egg, but Wells Fargo (NYSE: WFC  ) sports a 0.7% yield, JPMorgan Chase spits out 0.5%, and even Bank of America (NYSE: BAC  ) manages 0.3%.

But the fact that they pay some meager pittance isn't the point. The point is that banks used to be a key piece of any dividend-investor's portfolio, and now they're largely an afterthought. But that may be about to change.

If we're to believe reports circling late last week, then the Federal Reserve may be preparing guidelines for banks that want to start boosting their dividend payouts. Does this mean dividend investors are about to start drooling over banks?

Not so fast
"Juicy" isn't going to be the word we'll likely be using to describe the banks' dividends even if they are allowed to start hiking them again. Bloomberg dividend forecasts have Wells Fargo and JPMorgan doubling and quadrupling their dividends next year, but that will bring their respective payouts to all of 1.4% and 2%, assuming the stocks' prices stay put.

And with regulators keen on keeping egg off their faces, it's unlikely they'll be ready to see banks crank up payout ratios to pre-crisis levels. Prior to the meltdown, Wells Fargo had a payout ratio above 40% while JPMorgan's was in the 30s. Some analysts see regulators trying to keep payout ratios as low as 5% to 10%.

In other words, speculating on bank stocks on the hope that big, fat dividends are right around the corner will probably end in disappointment. In fact, for some banks, like B of A and Citi, dividend hikes may still be well out in the future.

So what do we do then?
This doesn't really change the bank-stock story all that much. Last week, I wrote a piece looking at some of the banks that have burned investors lately and offered my suggestions for how to avoid banking blowups. In short, the idea was to look for solid banks that have strong capital ratios, credit trends moving in the right direction, and conservative provisioning against potential losses.

Thinking more specifically about dividends, the approach is pretty much the same. But while in the last article I was willing to point out banks moving in the right direction, this time we're going to want banks that are already looking pretty solid. So we'll still require strong capital ratios and conservative provisioning, but this time we'll want banks whose trouble loans are currently a low percentage of their total book. We'll also have to limit the list to banks that have already repaid their TARP loans, since it's unlikely that regulators will allow banks to juice their dividends if they're still hanging on to that buoy.

Let's take a look at what's left.

Bank

Current Dividend Yield

Nonperforming Assets / Total Assets

Average Common Equity / Average Assets

Allowance for Credit Losses / Nonperforming Loans

Wells Fargo 0.7% 2.8% 9.3% 85%
US Bancorp (NYSE: USB  ) 0.8% 1.9% 9.3% 127%
PNC Financial (NYSE: PNC  ) 0.7% 2.2% 10.9% 108%
Comerica 0.2% 1.0% 10.8% 80%

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

Why do I like these banks? Because they have some of the best balance sheets in the business right now and will all be in a good position to raise dividends when the green light starts flashing. These all also happen to be on bank analyst Dick Bove's short list of banks that are likely to see dividend bumps.

That said, it's notable that with all of this talk of the "ifs" and "whens" of banks and dividends, investors don't have to be patient to find banks with decent dividends. The banks below all fit the same criteria as above, only this time they already have a meaningful payout.

Bank

Current Dividend Yield

Nonperforming Assets / Total Assets

Average Common Equity / Average Assets

Allowance for Credit Losses / Nonperforming Loans

BB&T (NYSE: BBT  ) 2.4% 2.8% 10.7% 93%
M&T Bank (NYSE: MTB  ) 3.4% 1.9% 10.9% 81%
Cullen/Frost Bankers 3.2% 1.0% 11.9% 87%
Commerce Bancshares 2.4% 0.5% 10.9% 220%

Source: Capital IQ.

If you're a lover of dividends, it's quite possible that the banking sector broke your heart over the past few years. Now that bank dividends may be coming back on line, "once bitten twice shy" may be your motto. But for dividend investors willing to open their hearts again, I think there may be banks out there worth getting to know better.

Dividend investing is at its best when you have a well thought out, diversified portfolio. My fellow Fools have put together just such a portfolio with 13 high-yielding stocks they think are prime for the picking. To see this free report, just click here and enter your email address.

The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


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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 November 10, 2010, at 5:10 PM, TMFKopp wrote:

    @GermanInvestors

    Profitability, whether we're talking about returns on equity or assets is no doubt important when researching banks. However, I would hesitate to call it a "better way" to go. Look back a few years before the crisis and you'll see a lot of banks with very good-looking ROEs that ended up getting clobbered.

    As my mom always used to say "safety first." The parameters I used above are good ways to get a feel for the safety of the banks. Once you have that down, then you can start worrying about returns and valuation.

    Matt

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