Banks Showing Some Dividend Potential

NEW YORK ( TheStreet) -- The dividend -- long one of the prime reasons to purchase a bank stock -- is showing signs of making a comeback in the sector.

Whether it's because of savvy strategy or the impact of an improved economy on the bottom line, a number of banks and other financial companies are once again starting to see dividend payments as an attractive use of capital. Even some firms that have only recently shed their bailout shackles are looking to boost payouts again.

Visa ( V), which never accepted bailout funds, this week became the first major financial firm to boost its dividend, lifting its quarterly payout to 12.5 cents a share from 10.5 cents. Bailout recipients JPMorgan Chase ( JPM), U.S. Bancorp ( USB) and State Street ( STT) all recently indicated a desire to lift quarterly distributions as well, after having cut them dramatically over the past year or so. A key factor holding them back is the promise of more stringent regulatory capital requirements, although when the Federal Reserve will unveil those standards, or what the extent of those standards will be, remains unclear.

>>TARP Weighs on Dividends: Slide Show

"When a bank is going to start increasing their dividends, first and foremost it's because they're generating income," says Russ Yates, an analyst with SNL Financial. But, he adds, "why a lot of these banks suspended dividends or greatly reduced them is because of what's coming about with this regulatory reform. Everybody thinks there's going to be higher capital requirements in the future, but nobody knows exactly what the higher capital requirements will be."

Despite the regulatory uncertainty, dividends are a hot topic. JPMorgan CFO Mike Cavanagh said last week that the firm is planning a "significant" dividend hike for the "early part of 2010." He said the bank may quintuple its annual payout of 20 cents per share to a range of 75 cents to $1.

U.S. Bancorp CEO Richard Davis said this past Wednesday that he is "well aware that the dividend is an important step in our shareholder focus." The bank's board is evaluating the timing and amount of a potential dividend boost, but expects to hold off until there is more capital guidance from the Fed. Davis said that if regulators don't provide more clarity by December, U.S. Bancorp may potentially raise dividends in following quarters.

State Street CEO Ron Logue also acknowledged on Tuesday that "the first big trigger point" for a decision will be new capital requirements. Once those issues are clarified, Logue said the firm plans to return to its former distribution rate of 20% to 25%.

The Fed's stress tests last spring required banks to maintain a Tier 1 risk-based capital ratio of at least 6% and a Tier 1 common risk-based ratio of at least 4% under severe economic conditions. Though future rules remain unclear, the first crucial step for banks looking to lure in dividend-focused investors is paying back TARP. Banks that accepted bailout funds were forced to restrict dividends, as well as stock buybacks and executive compensation, among other things.

"Only a handful of big banks have paid back TARP and thus can revisit dividend policy," says Roger Young, a portfolio manager who focuses on dividend stocks for Miller/Howard Investments, later adding, "If you're still on the government dole, you're precluded from it."

Of the 28 U.S. banks that boosted dividends this year, only three of them still hold bailout funds, according to data from SNL. Of banks with at least $5 billion in assets that still have TARP funds, 19% have halted dividends altogether and 39% pay just a penny a quarter.

Among those that cut to a penny are Bank of America ( BAC) and State Street, which may well have done so to maintain a presence in mutual funds that require dividend distributions. Others like JPMorgan, U.S. Bancorp, Morgan Stanley ( MS), Bank of New York Mellon ( BK), Capital One ( COF) and BB&T ( BBT) cut to at least a nickel simply to preserve capital. Others like American Express ( AXP) and Goldman Sachs ( GS) have kept dividends stable, but have held off on increases since the start of the downturn.

It has been difficult for dividend-focused fund managers to keep up returns over the past year when many reliable dividend payers slashed those rewards to retain precious capital. Blue-chip names like General Electric ( GE), Dow Chemical ( DOW), Pfizer ( PFE), Alcoa ( AA), Macys ( M), Motorola ( MOT), Weyerhaeuser ( WY), CBS ( CBS) and the New York Times ( NYT) have all cut quarterly distributions this year.

At the same time, a low interest rate environment has made it more difficult to make up for depleted dividends with other fixed income investments. Unfortunately, investors that opt for dividend-focused funds tend to be retirees who are heavily reliant on monthly distributions for income.

Investors who needed dividends to make ends meet were forced to "make some adjustments to spending priorities," according to Jim Rothenberg, head of Capital Research and Management Company, which provides investment advice to the American Funds family of mutual funds.

American Funds' Capital Income Builder fund, which has a strategy of increasing dividends over time, got burned last year by investments in Fannie Mae ( FNM), Freddie Mac ( FRE) and Washington Mutual, whose dividends and stock prices collapsed. At the end of 2008, financials represented 8.71% of Capital Income Builder holdings. Those holdings fell to 5.86% by April, but reversed course to represent 6.9% of net assets at Sept. 30 - good for the fund's second largest asset segment.

American Funds Web site says that in past economic cycles, "dividend-paying stocks have made solid gains early in any recovery," and asserts that "this will again be the case."

Few expect more troubled banks like BofA or Citi to start lifting dividends any time soon, but others that have repaid bailout funds -- or never accepted them, such as not only Visa but payments processing counterpart MasterCard ( MA) -- and have strong capital metrics may be among the first. Smaller, more traditional lenders that never accepted TARP funds are also in a solid position to raise dividends, and some have done just that throughout the financial maelstrom.

"As we report another quarter of record earnings, both on an overall and core level, we feel it is appropriate to increase the common stock dividend," B. G. Hartley, Chairman and CEO of Southside Bancshares ( SBSI) said in a statement on April 16. "We believe it is especially important to offer tangible rewards for our success in this challenging economic environment."

Southside, a regional bank based in Tyler, Texas, with $2.7 billion in assets, has been raising its dividend consistently for more than a decade and pays special dividends frequently. Its most recent quarterly payout was 14 cents, up from 10.88 cents last year, representing a second-quarter yield of 2.45%, according to SNL Financial. Its shares haven't been as volatile as bigger players either, ranging from $13.50 when the market tumbled last March, to a high of $27 in September 2008. It has recently traded in the mid-$23 range.

Southside has just 27 peers that have raised dividends in 2009, vs. 196 banks that have slashed payouts, according to SNL. But as more banks repay TARP, the economy continues to stabilize, and the Fed provides clarity on capital mandates, Southside's ranks are poised to grow.

At that point, says SNL's Yates, healthier banks will finally "be able to take some of the money and give it back to the shareholders."

-- Written by Lauren Tara LaCapra in New York.

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