Banks truly have made an amazing recovery since the financial crisis of five years ago, and the proof is in the Fed stress test pudding. Wells Fargo (NYSE:WFC) rode its strong performance in the Dodd-Frank Stress Test (DFAST) to a new 52-week high last week, with other banks, including much-maligned Bank of America (NYSE: BAC), 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. 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. Last year, Fifth Third Bancorp (NASDAQ:FITB) was among the best performers in the Federal Reserve-mandated stress tests, and it is off to a great start this year as well.
Should Fifth Third ask for a dividend increase or share repurchase?
As Fool Analyst David Hanson recently noted, Fifth Third showed strong capital ratios during the DFAST, ticking down just over 1% in the Fed's scenario. The results show that the bank will remain well-capitalized if it maintains the same dividend payout over the coming year. However, like most other banks that are part of the stress tests, Fifth Third will be seeking permission to raise its dividend above its current level.
Last year, despite its strong performance with the stress test, Fifth Third's request for an increased dividend was initially denied by the Fed, though the bank was allowed to increase its dividend later in the year. If its performance in the DFAST is any indication, the bank should be in position to not only boost its dividend again, but also return value to shareholders by repurchasing shares.
As a result of the CCAR last year, Fifth Third's board authorized the repurchase of up to 100 million shares without an expiration date. As of December 31, the bank had over 63 million shares of this authorization still available for repurchase, or they could simply issue a new authorization replacing the previous one. Even if the bank just continues to purchase shares from the previous authorization, shareholders will be rewarded as their share of income increases.
Fifth Third already boasts a pretty sizable dividend -- at least when compared to some other banks -- paying out just over 21% of its earnings as dividends during the past 12 months. With the Fed looking less favorably on payout ratios over 30%, I would expect only a modest dividend increase from the bank. Nevertheless, a 30% payout based on last year's earnings would represent an annual dividend of about $0.50 per share, boosting its current yield to around 3%. This, combined with even a modest share repurchase plan, could lead more investors to the bank down the road.