7 Bank Stocks With Dividends Set to Increase in 2011

By Jaime Peters, CFA, CPA | Senior Stock Analyst

As you may recall, the Ultimate Stock-Pickers Team put together an article earlier this year that highlighted some of the better yielding dividend stocks held by our top managers coming into 2011. With inflows into U.S. stock funds up during the first two months of the year, and equity markets struggling to continue the rally they started two years ago, we thought it would be interesting to take a deeper look at some companies held by our top managers--companies we believe are more likely to make meaningful increases to their dividends this year. In particular, we're looking more closely at the collection of bank stocks held by our Ultimate Stock-Pickers. These stocks had their dividends significantly cut during the financial crisis, but several are likely to raise their dividends this year.

For those who don't remember, the collapse of the credit and equity markets wreaked havoc on the banking sector, with aggregate holders of regional bank stocks like the  iShares Dow Jones U.S. Regional Banks (IAT) and  PowerShares Dynamic Banking  exchange-traded funds dropping as much as 50% in value from the end of September 2008 to the beginning of March 2009. During that same time period, shares of the big four banks-- Bank of America (BAC),  Citigroup (C),  J.P. Morgan Chase     (JPM), and  Wells Fargo     (WFC)--underperformed even more, with Bank of America and Citigroup both dropping more than 80% in value, Wells Fargo falling more than 60%, and J.P. Morgan dropping around 50%. Given the uncertainty created by the collapse of the equity and credit markets, many banks found themselves having to significantly cut (or, in some cases, eliminate) their dividends in order to preserve capital. This was further compounded by the infusion of TARP capital into the banks, which restricted the ability of these firms to increase their dividends for an extended period of time.

Looking at the actions by the big four banks, Bank of America cut its quarterly dividend in half (from $0.64 per share to $0.32) in October 2008, before cutting it again to $0.01 per share in January 2009. While Citigroup cut its dividend much earlier, from $0.54 per share to $0.32 in January 2008, the firm followed a stair-step path down with its dividend, which fell to $0.16 per share in September 2009, dropped down to $0.01 in January 2009, and was finally discontinued in February 2009. Even though they held up a lot better than either Bank of America or Citigroup, both J.P. Morgan and Wells Fargo cut their quarterly dividends by around 85% to $0.05 per share during the first quarter of 2009. While many of the top U.S. banks have repaid their TARP obligations during the last two years, the restrictions on dividend increases have remained in place.

That may all change this year, though, as the top 19 banks are currently going through another round of stress tests and may finally get approval from the Federal Reserve to raise their dividends. J.P. Morgan recently suggested that it likely would be getting an answer on its request to raise its dividend the week of March 21, 2011; back in January, CEO Jamie Dimon talked up the prospect of a $0.75-$1.00 per share annual dividend (compared to $0.20 currently). Believing most of the banks that are eager to raise their dividends have already talked about target ranges and are just waiting for the Federal Reserve's approval before pulling the trigger, we thought we'd look at the top bank holdings of our Ultimate Stock-Pickers to see if any of them were facing the same stress test, trying not only to gauge the likelihood of an immediate increase in their dividend, but figuring out what a normalized dividend rate might be for them as well as what that implies for future yields.

Top Eight Bank Holdings of Our Ultimate Stock-Pickers

 Star RatingMoat SizeCurrent Price ($)Price/ Fair ValueDividend Yield (%)Est. Qtly Dividend @ 2011YE ($)# Funds HoldingWells Fargo (WFC)4Narrow32.380.830.60.2511NY Mellon (BK)4Wide28.960.831.20.3310JP Morgan (JPM)4Narrow45.740.750.40.208B of A (BAC)3Narrow14.380.800.30.107U.S. Bancorp (USB)3Wide27.160.940.70.206Citigroup (C)4None4.570.700.00.005PNC (PNC)3Narrow62.910.940.60.203BB&T Corp (BBT)4Narrow27.10.852.20.202

Stock Price and Morningstar Rating data as of March 11, 2011.

  Wells Fargo (WFC)
Wells Fargo is not only the most widely held bank stock among our Ultimate Stock-Pickers, with eleven managers holding it as of the end of last year, but should be one of the first banks to raise its dividend this year. We believe Wells Fargo--with its massive earnings power--will sail through the most recent stress test and increase its $0.05 quarterly dividend to something in the range of $0.25 per share (which would represent a full-year payout of around 22% if the company meets our 2011 expectations). Even Warren Buffet, whose  Berkshire Hathaway (BRK.A) / (BRK.B) maintains 20% of its stock portfolio in the bank's shares, noted recently that, "Wells Fargo, though consistently prospering throughout the worst of the recession and currently enjoying enormous financial strength and earnings power, has ... been forced to maintain an artificially low payout." He expects the firm to "reinstate the rational dividend policy that its owners deserve" this year, with Wells Fargo even suggesting that it would like to return to a "normalized payout ratio of at least 30%." We are expecting the company to eventually reach 35%, which while below its historical long-term average, would have Wells Fargo paying around $0.35 per quarter by 2014, slightly above where it was before the firm cut its dividend in March 2009.  

 Bank of New York Mellon (BK)
Bank of New York Mellon fared better during the crisis than many of its peers, as its profitable and wide-moat custody business kept it from suffering to the extent that many of the more traditional banks did during the financial crisis. Still, the company did end up cutting its dividend to $0.09 per share (from $0.24) in April 2009--making the current payout ratio a measly 13% (based on our 2011 earnings estimate). Management points out that it "finished number one in the 2009 stress test" and expects the firm easily pass again this year. Once it does pass, we expect the bank will announce an increase in its quarterly dividend to $0.33 per share, representing about a 40% payout ratio for 2011. Bank of New York Mellon has been rapidly growing its capital base--adding more than 100 basis points to Tier 1 capital in the fourth quarter of 2010 alone--which demonstrates to us that the company has the ability to build capital while paying a higher dividend. That said, Morningstar analyst Michael Kon would like to see the bank's tangible common equity/tangible asset ratio exceed 6.5% before it considers reinstating share repurchases.

  J.P. Morgan Chase (JPM)
J.P. Morgan Chase is in a prime spot to raise its dividend. Management has talked about the dividend continuously during the last couple of months and has demonstrated its commitment to raising the dividend once it wins approval from the Federal Reserve. In the near term, we expect the bank to raise its quarterly dividend to something on the order of $0.20 per share. This represents a 12% payout ratio (based on our current estimates for 2011). While this might appear low to some investors, the bank has mentioned it would like to eventually bring its payout ratio up to 30%, which suggests to us that J.P. Morgan is looking to start with a lower payout, which it can then increase over time. That being said, we believe J.P. Morgan may be in the best position to raise its dividend more than once this year. In the long run, we expect the bank will find itself so overloaded with funds that it cannot deploy as profitably as it would like, that it raises its dividend payout ratio to about 35%--which would imply a $0.60 per share quarterly dividend by 2014. This would represent a nearly 60% increase over precrisis levels, a sure sign that J.P. Morgan's long-term results actually benefited from the financial crisis instead of being hamstrung by it.

 Bank of America (BAC)
Bank of America's performance throughout this crisis has been disappointing to say the least. The bank paid way too much for both Merrill Lynch and Countrywide, and has been hampered by all of the problems that those two firms engineered prior to the collapse of the equity and credit markets. Bank of America was forced to seek bailout money from the government more than once, and cut its dividend to just a penny per quarter in January 2009. The company has lost money in each of the last two years, due in large part to goodwill write-downs (from its poor acquisitions) and massive losses on its mortgage book. Despite all of this, Bank of America has finally laid out a path toward more normalized earnings and even applied to the government for a dividend raise in the second half of 2011. Even though Bank of America will not be one of the first banks to raise its dividend this year, we do expect the company's current penny per quarter dividend to reach a dime before the end of 2011.

 U.S. Bancorp (USB)
U.S. Bancorp has been one of the most vocal banks about wanting to raise its dividend payout during this time of stress. The bank remained profitable during the entire credit crisis and has seen its capital ratios soar as its massive ability to generate earnings was retained rather than paid out to shareholders. The bank has altered its future guidance on dividend and share buybacks, but remains one of the top banks dedicated to returning funds to shareholders. With a 2010 payout ratio of just 12% supporting its $0.05 quarterly dividend, we think the bank will likely raise its dividend to somewhere between $0.15 and $0.20 per quarter by the end of March. We could easily see U.S. Bancorp starting with a $0.15 quarterly dividend in the second quarter, then raising it to our $0.20 target a few months later. After that, we believe that the bank's dividend growth will be fairly muted, as its fundamental earnings growth is masked by the end of reserve releases in 2013 and 2014.

 Citigroup (C)
Investors holding Citigroup know they'll need to be patient about a dividend ever reappearing at the bank. Citigroup cut its common dividend to zero when the government was forced to bail it out by taking a 30% stake in the business in February 2009. The government is pretty much out of Citigroup, but the bank remains very cautious despite peer-leading capital levels. Management has suggested it will not return capital to shareholders until 2012 and our analysts do not expect anything different. However, with a Tier 1 Common ratio of 10.7% at the end of last year, and the ability to earn $0.75 per share this year on the back of provision releases, Citigroup will have plenty of capital to disburse to shareholders when it finally decides to do so. We expect the bank eventually will reinstate a dividend policy with around a 40% payout ratio and attempt to do some massive share repurchases. Citigroup's shares outstanding increased from 5 billion to 29 billion during the crisis, while the balance sheet shrank. Earnings-per-share power remains at a fraction of the firm's historical numbers, and as a consequence it is likely to take decades before Citigroup can return to precrisis dividend levels.

 PNC Financial (PNC)
PNC Financial used the credit crisis to execute a huge acquisition, picking up the battered National City franchise in late 2008 and using the following years to work its way through all of its problem assets. After declining to almost 2% in the depths of the crisis, PNC's tangible common equity ratio now stands at more than 7% (by our calculation), which makes Morningstar analyst Jim Sinegal believe that capital is no longer a problem for the firm and that the company has room to raise its dividend during the next six months. With that in mind, we believe that PNC has room to increase its dividend from $0.10 per share per quarter to $0.20-$0.25 per share before the end of the year. This would leave its payout ratio still at a relatively low 15%-20%, giving it more room later on to increase its dividend significantly. By 2014, we believe a 30% payout ratio would net investors $0.62 per share per quarter--giving PNC one of the most attractive dividend growth rates among the top banks during the next five years.

 BB&T Corporation (BBT)
BB&T has long been a favorite dividend stock at Morningstar, and with two of our top fund managers holding it, the firm just makes the cutoff for this list. BB&T's dividend story is a lot different than its peers', as the bank only cut its dividend to $0.15 per share (from $0.47 in May 2009), remained profitable every quarter during the crisis, and now is trying to increase a dividend that represents a 50% payout ratio already when the Federal Reserve seems to be guiding firms closer to 30%. Consequently, while we believe that BB&T is a great bank, we don't believe it will be one of the first banks to announce a dividend increase this year. We suspect the bank will have to wait until the second half of 2011, giving its earnings per share a much better chance for recovery. While we expect BB&T to announce a smaller dividend increase than its peers, we see the quarterly payout closer to $0.20 per share by the end of the year.

In the end, the top U.S. banks have a lot of capital on their balance sheets, and it is growing at a rapid rate as earnings power returns. Most banks have applied for dividend increases and we believe many of them will announce something within the next few months. This is reassuring to investors. Capital allocation decisions can destroy shareholder value in a heartbeat and banks, as a whole, generate more capital than they can profitably deploy. A strong payout ratio--of 30% or better--is needed at banks in normal periods, simply to keep capital levels from building up too much and giving management the opportunity to be "creative" with shareholder money. Much like our Ultimate Stock-Pickers, investors should be looking forward to more meaningful dividend checks in their mailboxes this year.

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Disclosure: Jaime Peters does not own shares in any of the securities mentioned above.