Banks aren't totally uninvestible from an income standpoint, but they simply don't offer the kind of income characteristics that they used to, says Morningstar's Josh Peters.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
With global banks under continued pressure, I'm here with Josh Peters, editor of the Morningstar DividendInvestor newsletter, to see if it's opened up any opportunities.
Josh, thanks for joining me.
Josh Peters: Good to be here, Jeremy.
Glaser: When you look at the banks both in the U.S. and abroad, what do you think is driving some of the volatility and the downward pressure we've seen in prices so far this year?
Peters: How could you not be panicking? It's never a good idea to panic, but when the sign in front of that interest rate turns negative, we're moving off into territory that we've never seen before. There is no real track record of what we should expect from banks, in particular, or economies in total, in a negative interest rate environment. And yet that's the territory that you're marching into in Europe and Japan. People even wonder if that will one day come to visit the United States. I still think the Fed is more likely to be raising interest rates as opposed to lowering them into negative territory. But it's nerve-racking.
Plus, you have the fact that outside the United States you haven't had as effective a cleanup of the banking system. Here in the United States, I look at our big banks and see they have a ton more capital. They're being regulated much more closely. I honestly think they're being over-regulated to the point where it's getting hard for them to fulfill their function of making intelligent loans and helping the economy grow, and helping businesses expand. But I don't have any fears in terms of safety and soundness.
Then you look at some of the big European banks that have not built up those bigger capital cushions the way our banks have, and it's a little bit nerve-racking.
So you don't have to be so shocked when Deutsche Bank just eliminates the dividend entirely. They need more capital, and they need a more coherent set of regulations to make sure that those institutions can serve the needs of their economies and provide some return to their shareholders.
Glaser: Do you think this means that dividend investors should just avoid the big banks, because there just isn't an opportunity there?
Peters: I'm not looking at any foreign banks at the moment. I feel like it's an industry where, based on my own experience back in 2008-2009, dividends are the first thing to get cut in a crunch: Let's just plug the hole. This is capital that regulators or, if they want to, management teams can say, we need to shore things up, so no more dividend for shareholders.
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You combine that with the fact that banks are inherently levered and are dependent, at least to a fairly large extent, on the health of the economies that they serve--it's tough. That doesn't mean that they are totally uninvestible from an income standpoint, but they simply don't offer the kind of income characteristics that they used to. In fact, even when they did, when I was buying bank stocks back in '05, '06, '07, I loved them. You got 4%-5% yields. Lots of them had dividend growth histories going back 30-40 years. You'd see high-single-digit dividend increases or better, year after year. They looked great. But even that proved not to stand the test of a serious downturn in the economy and reregulation of the banking sector.
Now I look at them not too dissimilarly than Bill Gross does, which is they have been forced into a utility-like risk-management approach, but without yet providing good returns on equity, like a utility can, without providing dividend yields that are comparable, and without demonstrating that they can grow earnings much without higher interest rates--which I think we'll get eventually, but I don't know when. I think it's pretty hard to make a good case for a lot of these bank stocks.
I only own one. I've owned Wells Fargo since November 2005. I still like it today, but it's almost the exception that proves the rule. They are the ones that have been able to generate good returns on equity and to deliver a good share of that return back to shareholders through dividends. Most banks are still way, way behind where they were back before the crash in terms of their per-share dividend rates.
Glaser: Do other U.S. banks-- JPMorgan or Citigroup--fall into that category of, you wouldn't be interested in them?
Peters: This is one of those cases where I can see the advantage of owning some stocks where you've got some upside to earnings, maybe upside to the dividend as well associated with a higher interest rate environment. It's great to find a hedge, if you can. However, I'm never going to buy something just because of its hedge characteristics. Every stock I own has to pull its own weight. Right now, Wells Fargo yields about 3%. Long-term, I think they can grow earnings about as fast as the economy grows--let's call that 2% real GDP, 2% inflation, 4% growth for the bank; some share repurchases bring that up to 6% for a long-term dividend growth rate of maybe 7%. And maybe they can do a little bit better than that. But that's adequate, and I get the benefit of the hedge.
But when I look at most bank stocks, you still don't have very many that yield even 3%. And among those that do, now you do have to wonder about some of the company-specific risks. Cullen/Frost is a name that I really love. I love this bank's history. It's an extremely conservative lender, but they are entirely within the state of Texas. The stock is well off its highs, but it's also lately now well off of its lows. I really agonized: Is this something I want to buy? But I have some concerns, more about the long-term dividend growth potential for the bank. If they really need the higher interest rates in order to drive dividend growth, I'm not confident enough in my ability to predict interest rates going up to say, yes, this is something that I definitely want to own in the same way that I can look at some other businesses that have very high-quality, very durable growth prospects, say in staples or utilities. I'm very confident in Duke Energy's ability to maintain a mid-single-digit type of dividend growth rate. Cullen/Frost, maybe that dividend growth continues, but at a very low level for a while, and that could be unrewarding.
Glaser: Josh, thanks for your thoughts on banks today.
Peters: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
