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Bank Dividends: Oasis or Mirage?

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Dividend yields may simultaneously be the best reason right now to buy American bank stocks and the best reason to avoid them.

Thanks to big banks’ share-price decline, combined with their firm line so far on dividends, the largest lenders are expected to yield as much on average as they have at any time since the financial crisis over the next year. They look particularly tempting when compared with 10-year U.S. Treasurys.

It is more than just a question about the economy. If it were, in purely earnings terms it seems feasible for now. After ending share buybacks, and despite large additions to loan-loss reserves, big banks still have capital at levels above what would mandate dividend cuts.

But current earnings aren’t the sole variable. The results of stress tests currently being conducted this month by the Federal Reserve, under a new set of capital rules with additional stresses emulating Covid-19 added in, are difficult to predict. The results of the examination could add potentially larger “stress capital buffers” to their requirements, raising the bar.

Under the new rules, though, banks also have choices about how to proceed. They could subsequently raise additional capital or shrink their balance sheets. Neither option is particularly attractive, and banks might find themselves under political scrutiny if they were reducing loans to preserve payouts.

There is also the question of how the Fed might proceed strategically if banks faced that choice. Sometimes the thinking has been that having all lenders make defensive moves, even if they don’t all need to, helps to not single out individual banks and focus investor and counterparty pressure on them.

But that might not be how things work this time around, especially since this isn’t presently a crisis emanating from banks. Selective dividend cuts could instead send the signal that the stress test was very strenuous, but that most banks passed this super-tough exam with the ability to maintain their payout. Allowing banks to proceed individually could be a sign of systemic strength while discouraging excessive risk taking.



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