Banks’ Dividend Boost on the Cards

On Friday, the Wall Street Journal reported that the much-awaited results of the stress tests conducted by the Federal Reserve would be out soon. The results will demonstrate if large U.S. banks’ balance sheets are healthy enough to boost dividends.

In January, all 19 banks, which were subjected to the stress tests in 2009, had submitted their capital plan to the Fed. These banks, including big names such as JPMorgan Chase & Co. (JPM), Citigroup Inc. (C) and Wells Fargo & Company (WFC), need to show that they have adequate capital to address potential losses over the next two years under various scenarios.

These are essentially precautionary measures amid the economic recovery. Though, banks such as KeyCorp (KEY) and SunTrust Banks Inc. (STI) are also subjected to the stress tests, Fed will not allow them to hike dividend as they have not repaid their bail-out money.

Due to the recession, the Fed had barred all the banks from increasing their dividends. As many of these banks repaid the bailout money, they began pressuring the regulators to let them restore their dividends.

In 2010, the banking industry paid nearly $53.9 billion in cash dividends compared with $110.3 billion in 2007 (pre-crisis period). Many of the U.S. banks including Bank of America Corporation (BAC) and SunTrust currently pay a penny per share as quarterly dividend.

At present, several banks, such as JPMorgan, Wells Fargo, SunTrust and BofA, have dividend yields below 1%, while some banks, such as Citigroup, have not paid any dividend at all for the last couple of years. So, with the stress test results coming out, these banks are expected to double or triple their dividend yield later in 2011 or 2012.

According to the Federal Deposit Insurance Corporation (FDIC), about 68% of the banks in the country reported year-over-year growth in 2010. This is also likely to help these banks raise dividend payout ratios. Before the financial crisis struck, banks had targeted an average dividend payout ratio of about 40%. Now, they wish to have a dividend payout ratio of at least 30%, following the stress test results.

Hence, the investors and banks are viewing the Fed’s decision regarding the dividend hike as a sign of economic recovery. So, if most of the major banks pass the stress test and consequently get the permission to increase dividend, it will definitely boost investors’ confidence in the U.S. Banks.

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SUNTRUST BKS (STI): Free Stock Analysis Report

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