No Stress: Banks Poised to Increase Cash Payouts to Shareholders

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Several banks will release their earnings reports for the fourth quarter of 2012 over the next few days. As they prepare, they are also readying for the results of the latest round of stress tests that may affect how investors value their stocks even more than the earnings reports.

That’s because the stress test determines whether or not they can launch share buyback programs or pay dividends. Specifically, banks wishing to pay or increase dividends or launch shareholder buyback programs must essentially submit requests to the Federal Reserve for approval.

The stress tests are a result of the Dodd-Frank Act. The act and its many elements are meant to keep the financial sector from experiencing the kind of collapse that claimed banking giants Lehman Bros. and Bear Stearns.

Passing the stress test means a financial institution has enough capital to survive times of economic and financial stress while still being able to lend to households and businesses. Banking institutions were criticized for spending capital to pay shareholders while knowing full well their finances were strained. These stress tests are meant to squash such practices by limiting banks from being able to go through with dividend and/or share buyback programs without having sufficient levels of capital.

No two banks are more familiar with the repercussions than Bank of America (NYSE: BAC) and Citigroup (NYSE: C). Bank of America had its proposed capital payout rejected in 2011. While Citigroup passed the test, the Fed still rejected its plan to increase its dividend over concerns about its capital levels.

Banks had until Jan. 7 to submit their plans to the Federal Reserve. The results are expected to be announced in March. This year marks the third round of stress tests. The banks have been relatively quiet about whether or not their plans included returning cash to shareholders. They've also been mute about the amounts of any of their plans. However, there have been several ideas bandied about among market players. For example, Citigroup and JP Morgan (NYSE: JPM) are expected to ask for a dividend increase and a share repurchase. Morgan Stanley (NYSE: MS) will likely ask for neither but is expected to lobby for the Federal Reserve’s approval for it to acquire all of a wealth-management unit it has through a joint venture with Citigroup.

It’s anybody’s guess whether or not these plans will be approved by the Feds. However, I think that given banks are in a much stronger position now, and have sufficient capital to pass the stress tests, their requests will be approved.

Banks enjoyed robust earnings over the course of 2012, which was in stark contrast to the lows they suffered after 2008. While they still face their share of struggles, especially due to the mortgage lending debacle, most of their finances have rebounded.

To get an idea of the strength of the financial sector, I looked at the Financial SPDR ETF. It tracks more than 80 diversified financials. It is up more than 4% since the beginning of the year; and it is up 23% from one year ago. Also, there is a general sentiment that earnings will be relatively strong. Some estimates place the earnings growth rate for the sector this year at around at least 8%.

JP Morgan releases its report on Wednesday, while Bank of America and Citigroup will release their fourth quarter earnings reports on Thursday. Morgan Stanley will release on Friday. Wells Fargo released its earnings for the fourth quarter last week.

 


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