During February 2009, the Federal Reserve conducted a stress test of sorts, one in which evaluated the capital levels of the nineteen largest U.S. bank holding companies, those deemed “too big to fail.” As a result of this test and according to a press release from the Federal Reserve, “the Federal Reserve advised bank holding companies that safety and soundness considerations required that dividends be substantially reduced or eliminated. Since that time, the Federal Reserve has indicated that increased capital distributions would generally not be considered prudent in the absence of a well-developed capital plan and a capital position that would remain strong even under adverse conditions.”
In laymen’s terms, the Federal Reserve was attempting to make certain that the largest U.S. Banks had adequate capital to take them through another financial crisis without being bailed out by the U.S. Treasury.
Speed forward to present day. A week ago Friday, the Federal Reserve announced that it had completed a second stress test, called the Comprehensive Capital Analysis and Review (CCAR) and as a result announced that “some firms are expected to increase or restart dividend payments, buy back shares, or repay government capital.”
One of the banks that have since announced dividend increases include J.P. Morgan whom raised their dividend from $0.05 per share per quarter to $0.25 per share per quarter for a yield of 2.18% based upon the closing price Thursday, March 24. Prior to the whole financial mess that came to a head during early 2009, J.P. Morgan was paying a quarterly dividend of $0.38 per share resulting in a yield of more than 3.00%. We believe that if an investor were to own only one bank, it would be J.P. Morgan. We believe that they provide the best opportunity for capital appreciation relative to the risk that you would be assuming. In addition, we believe that further dividend increases are likely and would provide a hedge against inflation.
Another bank that responded to the recently concluded CCAR by raising their dividend was Wells Fargo which announced a special $0.07 per share dividend for the first quarter in addition to their normal $0.05 per share dividend for a total dividend of $0.12 per quarter. We believe that this “special” dividend may be incorporated into their normal dividend for the second quarter and beyond. If so, Wells Fargo will now pay an annual dividend of $0.48 per share for a yield of 1.50% based upon their closing price Thursday, March 24. In addition, the Board of Directors of Wells Fargo announced a 200 million share buyback plan totaling $6.4 billion.
Finally other financial institutions either announced dividend increases, share repurchases or plans to begin to repay the TARP funds borrowed by banks from the Federal Government.
THE BOTTOM LINE – It appears as if the Federal Reserve believes that the worst is behind us for the economy and as such the banks. However, more so now than ever, there will most likely be a wide moat between the winners and the losers. We believe that J.P. Morgan is a winner. Another bank we are high on that is not cited in this column is First Niagara, a bank that combines the potential for capital appreciation along with solid income from dividend payments.