Which U.S. bank will hike pay-outs most?

The Federal Reserve’s OK for U.S. banks to pay out 100% of earnings–should they wish to–turbo charges the ‘substitution effect’ on their shares

The Federal Reserve’s OK for U.S. banks to pay out 100% of earnings–should they wish to–turbo charges a ‘substitution effect’ on their shares.

Despite the Trump administration having been hamstrung by an investigation into alleged collusion with Russia, bank stocks have rallied since a nervy tumble at the end of Q1.

It’s as if investors have decided White House policy—which promises massive deregulation—is superfluous. To an extent, that’s turning out to be the case. Four interest rate rises between December 2015 and this month offloaded much weight from lenders' margins. Ongoing capital bolstering, deleveraging and balance sheet clean-ups also helped banks filter more cash to their bottom lines.

So the Fed’s announcement overnight that all 34 large U.S. banks passed its latest stress test, whilst important, is in fact just one of many milestones in their recuperation from near-death in the financial crisis.

It’s why banks are one of the few sectors still aloft on Thursday, as U.S. stock markets see their biggest one-day drop this year.

Pay-out scope-out

Still, in practice, no lender is likely to pay-out cash equivalent to 100% of earnings. Doing so would risk a blowback from institutional investors. However, with balance sheet growth constrained by a fragile yield curve – ‘capital optimisation’ – AKA share buybacks — could step up a gear among the ‘bulge bracket’. It’s notable that Citigroup–one of the least-profitable big banks –announced within hours of the stress test result that it would double its quarterly dividend and hike buybacks by $15.6bn to $18.9bn over a year.

Sticking with the U.S. ‘Big 6’ we think that in the medium term, investors will favour lenders perceived to have the greatest firepower to boost shareholder returns. Additionally, we expect investors are to react most positively to the ‘bulge bracket’ banks that pump dividends highest above the market average. But we see one exception which proves the rule that it is usually a warning sign when a company’s dividend yields overshoot the sector.

Our table below grabs projected dividend coverage ratios for the giant U.S. banks as of Thursday. It also show how high their yields are running above the average for the wider North American bank sector.

DIVIDEND COVERAGE FORECASTS/ YIELDS RELATIVE TO SECTOR

Name

Last

Pct. Chng.

Net Chng.

Close

Projected Dividend Cover

Dividend Yield Relative to Sector (%)

GOLDMAN SACHS

225.05

0.8198

1.83

223.22

6.866

100.83

CITIGROUP

67.34

3.3139

2.16

65.18

8.5

49.98

WELLS FARGO

55.875

2.8437

1.545

54.33

2.631

142.42

MORGAN STANLEY

44.78

1.0379

0.46

44.32

5.05

135.42

BANK OF AMERICA

24.385

2.1147

0.505

23.88

5.46

63.95

JPMORGAN

91.41

1.7702

1.59

89.82

3.3

113.35









Source: Thomson Reuters and City Index

 

Citigroup’s pockets deeper than Wells’

Citigroup’s motivation for its massively enhanced share buybacks immediately becomes clear: its dividend pay-outs are punching below its weight relative to yields paid by rivals. Still, it has cover to pay planned dividends to shareholders 8 times (in theory) under its current policy, the best coverage in the group. That partly explains why Citigroup shares have outperformed the bulge bracket with a 13% rise year to date.

Goldman Sachs follows close behind with 6.86 cover and a yield that is double the average of an ordinary U.S. bank. However its stock is the worst performer this year, down 6.2%. That’s due to a surprising ‘miss’ in Q1 from a failure to capitalise on a bond trading boom on the cusp of last year and this. GS could, however, lose the laggard label due to an apparently superior capability to boost shareholder returns.

By contrast, Wells Fargo has the worst projected ability among peers to cover dividends. Whilst its 2.6% coverage suggests it is good for planned pay-outs more than twice over, with the highest yield relative to the sector, and a structural misalignment to faster growing segments of banking (e.g. trading) investors may cool on its stock. That could push its meagre 1.2% rise so far this year back into the red.

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