NEW YORK (TheStreet) -- While the elections and the "fiscal cliff" negotiations in Congress have investors in a world of worry, bank stock investors can look forward to some good news as we head into the next round of Federal Reserve stress tests.
The 19 largest U.S. banks are required to submit their own annual stress test results to the Federal Reserve in early January, along with their plans for returns of capital to investors for the remainder of 2013 and the first quarter of 2014. While the increase in dividend and payouts and stock buybacks may be relatively modest, the banking industry's profitability continues to grow, and the major players have been building capital for several years now. Long-suffering investors are looking for a greater cut.
Deutsche Bank analyst Matt O'Connor said on Tuesday that "key assumptions and scenarios for the 2013 CCAR [Comprehensive Capital Analysis and Review] process are expected by Nov. 15," and said that "on the one hand, capital and liquidity levels are high, credit quality is improving and balance sheet growth is modest," all of which "suggest capital deployment levels should be up meaningfully from the roughly 35% combined dividend and buyback payout ratio for 2012."
"However, we expect the Fed to be conservative given continued macro uncertainty, the sluggish job market and still tight credit (by banks)," O'Connor said, adding that because of the weak job growth and strict lending standards, "we have a difficult time thinking (from a political point of view) that capital deployment can equal/exceed annual earnings until unemployment has come down and credit standards have been loosened."As we have seen over previous years, O'Connor expects the "market sensitive banks" -- including Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), Morgan Stanley (MS) and JPMorgan Chase (JPM) -- to be limited to capital deployment ranging between 25% and 30% of earnings, with the Federal Reserve allowing super-regional banks to have combined payout ratios (including dividends and share buybacks) of "about 60% on average." As we saw with JPMorgan Chase this year, after CEO James Dimon first announced in May that the company was looking at a large second-quarter trading loss from the hedging activity of JPM's Chief Investment Office, a large buyback program -- in this case $15 billion planned through the first quarter of 2013 -- can be abruptly suspended. Even though JPMorgan still wound up with a $5 billion second-quarter profit and was even more profitable in the third quarter, the buyback program has not been restarted. JPMorgan's shares already have an attractive dividend yield of 2.84%, based on a quarterly payout of 30 cents and Monday's closing price of $42.27. O'Connor expects JPMorgan's dividend payout to increase to $5.567 billion in 2013 from $4.656 billion in 2012, with the stock's "implied yield" climbing to 3.3%. The analyst said that "we believe expectations are too high for JPM in particular," and does not expect JPMorgan to resume common share buybacks in 2013. As large-cap banks have strengthened over the past two years, regulators have generally held the line on dividend payout to roughly 30% of earnings. O'Connor said that "we expect some softening of the 30% dividend payout cap in 2012, possibly to a range of 30-40%," in which case, he expects the highest yielding bank stocks under his coverage to be Fifth Third Bancorp (FITB) of Cincinnati, with a dividend yield of 4%, Wells Fargo (WFC), with a yield of 3.6%, and BB&T (BBT) of Winston-Salem, N.C., with a yield of 3.4%. The following are the three super-regional banks that O'Connor expects to have the highest combined ratio of common stock dividends and share buybacks in 2013:
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