Bank of America (BAC 1.99%), the second-largest bank in the U.S. by assets, has achieved a lot over the past year. It survived a global pandemic and performed well through an intense economic downturn and in an extremely low-interest-rate environment. It also received a big nod of approval from legendary investor Warren Buffett: Berkshire Hathaway (BRK.A 0.32%) (BRK.B -0.06%) bought more than $2 billion worth of the bank's stock, even as it eliminated or trimmed most of the other bank holdings in its portfolio.
Despite all this, its dividend payouts have lagged those of its big-bank rivals. But considering that its performance is now at the top end of its peer group, I expect this may soon change.
To see how Bank of America's payouts have come up a bit short, let's first look at the most common metric investors use to gauge them: dividend yield. That, simply, is the sum of annual dividend payments divided by the company's share price. Below, I took each bank's total dividend payouts from 2020, and divided by its closing share price Friday.
|JPMorgan Chase (JPM 0.05%)
|Bank of America
|Citigroup (C 0.63%)
|Wells Fargo (WFC 1.26%)
At 1.9%, Bank of America's yield trails them all. Additionally, it's slightly behind the average dividend yield of the banking sector, which is currently a little over 2%, according to S&P Global Market Intelligence.
Dividend payout ratio
One can also look at a company's dividend payout ratio -- the percentage of its earnings that a company allocates to dividends on an annual basis.
|Dividend Payout Ratio 2019
|Bank of America
Bank of America had the smallest dividend payout ratio in both 2019 and 2020. The ratios last year were elevated because earnings took a hit due to the pandemic. Banks tend to be a little more conservative than average with their dividend payout ratios. In some other sectors, it would not be uncommon to find payout ratios ranging from 50% to 70%. But the big banks have also been using some of their earnings to repurchase billions of dollars worth of their own stock in recent years.
The other consideration when it comes to bank dividends specifically involves their regulatory capital requirements. A bank must maintain a certain amount of capital in relation to its risk-weighted assets, so that even if it must absorb significant unexpected loan losses, it will still be able to lend during an economic downturn.
For this reason, banks' ability to pay out dividends and buy back stock is limited by regulators. One measure of capital relative to risk-weighted assets is the common equity tier 1 (CET1) capital ratio. If a bank falls below its CET1 minimum, it can still return capital to shareholders, but it may be limited in how much it can return, so banks try to avoid going anywhere near that threshold unless they absolutely have to.
|Required CET1 Ratio
|Bank of America
As you can see above, all four of the big U.S. banks have a ton of excess capital above their required CET1 minimum ratios. And normally, that excess capital will not get depleted because banks typically make capital distributions from their earnings each quarter. Leftover earnings essentially get added to the excess capital cushion. Even so, Bank of America's $36 billion in excess capital is a huge amount and significantly more than the other banks have.
Catching up with competitors
As Bank of America has said before, it doesn't have a lot of ways to spend all of its excess capital. It can't go out and buy another depository institution because U.S. law prohibits any bank from purchasing its way into owning more than 10% of all U.S. deposits. In other words, two institutions can't combine if the post-merger bank will hold more than 10% of those deposits.
As it happens, Bank of America already does hold more than 10% of all U.S. deposits -- but it grew into that status organically, and its other large acquisitions since it did so involved institutions that federal regulations didn't consider "banks."
So Bank of America will continue to grow organically and invest in its operations, but that spending can only reduce its excess capital by so much.
And yes, it will likely buy back tens of billions of dollars worth of its stock over the next few years, but so will the other big banks. Bank of America is also arguably in the best position among its peers to return capital to shareholders. Not only does it have the most excess capital, but it's not dealing with any potential issues in regards to the supplementary leverage ratio like JPMorgan. It's also not dealing with heavy regulatory issues that require major investments to correct as are Wells Fargo and Citigroup.
That's why I would expect that management at Bank of America would want to boost its dividend payout until it was more in line with its peers -- or even to bump its yield up until it surpasses theirs, because that's another way to stand out. And if you're an institution with $36 billion in excess capital, and you're somewhat limited in terms of ways that you can deploy it, why not start by being more aggressive with your dividend?