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.