It's March, and along with the return of spring (hopefully), we also get the results of the latest round of Federal Reserve stress tests. Last year, SunTrust (NYSE:STI) was among the worst performers among the banks put to the test, but this year, if its Dodd-Frank Stress Test (DFAST) results are an indicator of what's to come, the regional bank has shown marked improvement.
Banks truly have made an amazing recovery since the financial crisis, and the proof is in the Fed's stress-test pudding. Wells Fargo rode its strong performance in the DFAST to a new 52-week high last week, with other banks, including much-maligned Bank of America, also performing well in the DFAST. But the DFAST is only part one of the now two-part Fed stress tests.
Part two -- the Comprehensive Capital Analysis and Review (CCAR) -- will release results on Thursday afternoon. In this test, a bank submits a potential increase to its dividend and/or share buyback plans to the Fed, who then tests to see if the bank is capitalized well enough to meet the obligation. Though the DFAST wasn't part of the stress test last year, we can compare the results from last year's CCAR to see if a bank is looking better or worse.
Should SunTrust investors bank on a dividend increase?
Last year, because of its poor performance in the CCAR, SunTrust was not allowed to raise its dividend or return additional capital to shareholders. However, upon the release of last year's results, CFO Aleem Gillani stated that he felt the bank was better capitalized than the Fed's tests had shown, and that the bank would report first-quarter earnings that exceeded expectations. The bank proved him right, beating analysts' expectations by nearly 40% the following month, primarily on the strength of improved asset quality.
As Fool Analyst Matt Koppenheffer recently noted, SunTrust's capital ratios compared to last year are night and day. Not only did it increase its pre-test Tier 1 common capital ratio, but it also demonstrated that even after the Fed's "doomsday" scenario, SunTrust remained capitalized well above the 5% minimum required to pass the test. We'll get a clearer picture after Thursday's CCAR results, but I personally think SunTrust investors could see a slight dividend increase going forward.
How much of an increase?
As a result of the CCAR last year, SunTrust was not allowed to increase its dividend beyond its current $0.05 per quarter, or return additional capital to shareholders. SunTrust's current payout ratio is only around 5.5%, though this number is depressed slightly due to the sizable gain SunTrust experienced when it sold of some legacy Coca-Cola shares during the third quarter. Nevertheless, there is plenty of room for the bank to grow its dividend. Analysts expect SunTrust to earn $2.69 per share during 2013; if it maintains its current dividend, that would push its payout ratio to only 7.4%.
This would fall well below the 30% payout ratio ceiling the Fed seems to have placed on dividend patout ratios, giving SunTrust plenty of room to grow its payout. I don't expect them to raise the dividend all the way to this ceiling; a modest increase of $0.03 per share per quarter would result in a payout ratio near 12% based on projected earnings. At this level, the bank will still be lagging other banks in terms of dividend yield, but it will also leave room to increase its dividend in the future, especially if it's able to continue its strong performance from 2012.