Bank of America’s Dividend Boost Means More Than You Think

Shareholders of Bank of America (NYSE: BAC  ) can officially celebrate. On Wednesday, the Charlotte-based bank announced it gained approval from regulators to boost its quarterly dividend to $0.05 per share and repurchase $4 billion in common stock.

In the years since the financial crisis, the nation's largest banks are no longer free to allocate capital as they see fit. They must instead seek permission from the Federal Reserve to do so as a part of the annual Comprehensive Capital Analysis and Review process.

The central bank released the results of this year's CCAR yesterday afternoon. Although a handful of lenders had their capital requests denied, Bank of America's was ultimately approved, albeit after the bank submitted an amended request.

"Over the last few years, we have focused on positioning the company to return capital to our shareholders," said CEO Brian Moynihan. "We know that increasing the common dividend is important to our shareholders and we are pleased that we can continue to return excess capital through both repurchases and dividends."

Although it seems obvious in hindsight, the fourfold dividend increase was far from certain. In the first case, Bank of America fared considerably poorer in this year's Fed-administered stress test than it had forecasted internal. As my colleague Patrick Morris discussed here, the bank greatly underestimated the financial damage the Fed believes it would suffer if the economy took another dive akin to the financial crisis.

Additionally, there are multiple reasons the bank's executives prefer share buybacks over dividends. Among other things, Bank of America's stock still trades for a discount to book value, making buybacks a particularly attractive proposition, and Moynihan had previously said he wants to combat the dilutive impact of the financial crisis.

These issues aside, Bank of America made the right decision. Investors in the bank had been pining for a boosted dividend. Not so much for the increased income, but rather for what it says about the bank's fiscal health.

As I've discussed before, the Fed has set the bar for dividends much higher than for share buybacks. Under the central bank's estimation, buybacks are finite in nature, whereas dividends are presumed in the CCAR process to go on indefinitely; the implication being that the latter can consume critical capital in times of need, while the former will not.

The net result is that Bank of America's ability to raise its dividend stands as tangible confirmation of the progress it's made since 2009. It means the Fed is satisfied with the bank's capital reserves. And it also means regulators are sufficiently convinced of Bank of America's future earnings potential.

To be clear, this by no means implies that Bank of America is now on par with more adroitly managed peers like JPMorgan Chase or Wells Fargo. But it does mean the nation's second largest bank by assets is one giant step closer to this objective.

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