Bank Dividend Yields Soon to Beat CD Rates

Safety-minded investors have spent the last couple of years grumbling about bank CD rates, which have hovered slightly above ZERO percent since the bottom of our financial crisis. Investors will soon have an alternative to low CD rates if they're willing to get back into the stock market.

The Big Banks are about to increase their dividend payouts, and eventually those payouts will return to the levels of a few years ago. However, some smaller banks have never stopped offering high dividend yields. Consider First Niagara (symbol FNFG) with its dividend of well over 4%. Or New York Bancorp (NYB), which pays a higher rate. Or Hudson City (HCBK). All sound banks with great yields.

Moreover, these banks are possible takeover targets, though First Niagara is about to complete the acquisition of NewAlliance (NAL), a Connecticut bank with 88 branches.

Banks Are Poised to Pay Dividends After 3-Year Gap

Financial analysts say the nation’s largest banks are ready to begin restoring their dividends in the first half of the year, after a three-year pause to repair their damaged balance sheets. The reversal could put billions of dollars in the pockets of pension funds and retirees who had viewed bank shares as dependable sources of income.

Clues to how big a payout is in store could come as early as Friday, when JPMorgan Chase announces its 2010 financial performance, the first of many earnings reports to come over the next week from the likes of Bank of America, Citigroup, Goldman Sachs and Wells Fargo.

If the big banks deliver a second straight year of rising profits, as many analysts expect, the conditions would be in place for regulators to approve dividend increases by as early as March.

As the financial crisis worsened in 2008 and 2009, all but a handful of financial institutions cut their once-lucrative dividends to just pennies a share, hurting ordinary investors who had come to see them as sources of income. JPMorgan, for example, now has a dividend of 20 cents a share annually, down from $1.52 before the crisis.

Over all, the financial sector of the Standard & Poor’s 500-stock index paid out $51 billion in dividends in 2007. By 2010, that figure had shrunk to $19 billion.

“It’s a significant milestone,” said Gerard Cassidy, a veteran bank analyst at RBC Capital Markets. “The return of dividends signals that the banks are back, and the Federal Reserve wants to inspire confidence in the marketplace so that banks lend more.”

The financial industry has returned to health much faster than expected, helped by an alphabet soup of federal aid programs totaling more than $3 trillion, ultralow interest rates and a surging stock market.

Banks are expected to record $70 billion in profits in 2010, according to Foresight Analytics, a financial research firm. That would be up from $12.5 billion in 2009 but remains about half the level reached in 2006, before the housing market collapsed and the financial system almost came undone.

The earnings reports for the fourth quarter of 2010 are also likely to show that corporate and consumer lending is starting to come back while losses on bad loans are continuing to ease.

Wall Street’s trading businesses are expected to turn in a strong performance because of an increase in deal-making activity late in the year.

This week the Federal Reserve began another round of so-called stress tests of the nation’s 19 largest banks, evaluating their ability to remain financially healthy in the face of a still-anemic economic recovery and tough new regulations that will cut deeply into revenues. Unlike the first round of tests, the findings this time will not be made public.

Before approving a dividend increase, regulators must sign off on a bank’s stress test and conclude that the bank can meet the higher capital requirements put in place by new international agreements and the recent overhaul of financial regulations in the United States. They also must have fully repaid any federal bailout funds they accepted at the height of the crisis.

While the return of dividends will be welcomed by ordinary investors, it remains a delicate issue for the banks as well as regulators and politicians in Washington, said Chris Kotowski, a bank analyst with Oppenheimer.

Many voters are still angry about the government-led bailout that rescued banks after the collapse of Lehman Brothers in 2008. More recently, the return of bonuses on Wall Street has stirred outrage.

“It’s purely a matter of making it palatable to the public,” Mr. Kotowski said. “Banks are fully capable of doing it. But everyone’s afraid of headlines that say just two years after the bailout, the fat cats are getting dividends again.”

Partly as a result, he said, dividends will probably be restored in stages, and it could be take until the end of 2012 for them to return to historical norms.

For decades, shares of banks, along with utilities, were the favored choice of retirees and other conservative investors who looked forward to a steady payment each quarter.

That all changed when the financial crisis struck, forcing Citigroup to cut its dividend as it braced for a wave of huge losses tied to loan defaults.

Although the federal bailout program did not require banks to lower their dividends in most cases, regulators all but forced many banks into making cuts by insisting that they hold more capital in reserve to cushion against losses.

By the spring of 2009, several of the largest banks — including JPMorgan, Bank of America and Wells Fargo — cut their dividend to just pennies a share each quarter.

Just as the banks cut their dividends at different rates over the course of months, the timing of dividend increases will probably also vary widely across the industry. The strongest banks, including JPMorgan, State Street, U.S. Bancorp and Wells Fargo, should be in the first wave this spring, several analysts said.

For Bank of America and Citigroup, which continue to suffer steep losses on mortgages and consumer loans, the analysts said higher dividends probably would not come until later this year or early next year.

Several regional lenders, including Fifth Third Bank, KeyCorp, SunTrust and Regions Financial, are barred by regulators from raising their dividends. None of these banks have repaid their bailout money in full.

In particular, analysts and investors are eagerly anticipating what the chief executive of JPMorgan, Jamie Dimon, will say on the company’s earnings call on Friday, looking for any hint of the bank’s dividend plan. JPMorgan emerged from the financial crisis in far better shape than most of its rivals, and Mr. Dimon has been outspoken about his desire to raise his company’s payout.

“We’re going to be building up a lot of excess capital,” he said in a CNBC interview on Tuesday. “So, we would like to restart a dividend.”

Eventually, JPMorgan’s restored dividend could equal $1.50 a share annually, said Michael Scanlon, senior equity analyst with Manulife Asset Management in Boston. That would equal a yield of 3.3 percent based on its closing price of $44.45 on Thursday.

That would be up from 0.5 percent now. More important, it would catapult the yield on JPMorgan shares to far above the 2.26 percent yield on certificates of deposit, a popular vehicle for investors seeking income.

“It won’t come right out of the chute at that level,” Mr. Scanlon said. “But it’s definitely the end of a long drought.”

Banks Are Getting Together Again

The banks are restless. They're merging again, which is good news for bank investors, but probably bad news for some bank employees. Layoffs and staff reductions will follow.

First Niagara's Path Could Be Game-Changer

NewAlliance Bancshares (NAL) * Top-Rated Company

Buffalo, N.Y.-based First Niagara Financial Group (FNFG) has made two moves that could be seen as potential game changers.

First, the company gained approval from the Federal Reserve Board in April to change its classification from a thrift holding company to a bank holding company.

This cleared the way for First Niagara Financial to more easily expand through acquisitions.

The second potential game changer is an acquisition that's expected to wrap up in April, pending regulatory approval. On Dec. 20, shareholders approved a plan for First Niagara Financial Group to buy Connecticut-based NewAlliance Bancshares (NAL).

The move will make First Niagara a top-25 bank by assets.

First Niagara has 257 branches in New York and Pennsylvania. The NewAlliance acquisition will add 88 branches in Connecticut and Massachusetts.

First Niagara has acquired three insurance subsidiaries since August and bought Pennsylvania-based Harleysville National in April.

First Niagara's share price is up 19% since the NewAlliance merger proposal was announced Aug. 19. It was the largest merger of U.S. lenders since October 2008, according to Bloomberg.

First Niagara cleared a 13.89 buy point in a double-bottom base Wednesday. But it hasn't yet found strong volume. The stock is about 3% past the potential buy point.

Earnings grew 29%, 175% and 229% in the past three quarters, according to Thomson First Call. Loan losses dropped about 27% in the most recent quarter.

First Niagara pays a quarterly dividend of 15 cents a share. The annualized dividend yield is 4.2%.

One negative is the Dodd-Frank Act. The law is increasing bank costs and limiting activities that banks choose to take on.

Treasury Secretary Geithner -- Master of Disaster?

Tomorrow Secretary Geithner will release some details of the Big Bank “stress test”. How will the financial doctor measure the health of the banks with more than $100 billion in assets -- the ones required to get on the treadmill? Will Secretary Geithner disappoint the markets yet again? Hopefully not. But his previous appearance was disastrous.

If we're lucky, investor concern surrounding the banks will ease a lot after details of the Geithner stress test are revealed. However, no matter what he says, the idea of a single stress test for all our largest banks is a dumb idea. Moreover, it's likely he will introduce a new capital ratio to measure bank quality, and this is another dumb idea.

Why? First, the big banks are alreadyexamined and stress-tested by their on-site examiners-in-charge. These people are in a far better position to assess each bank’s unique characteristics and evaluate each bank's inherent risk. They are on the ground with the banks and able to know and learn far more than people conducting tests from high altitudes.

Second, there's plenty to question when it comes to the new ratio Geithner might adopt. It's probably a ratio of tangible common equity to risk-weighted assets (TCE/RWA). It seems Treasury has decided to look at TCE/RWA because spooked investors are determined to view banks in the worst possible light and are obsessed with the number. As general rule, it's a bad idea for investor anxiety to drive regulatory policy.

Regulators usually avoid pulling new measures out of the air. In the 1980s, the Fed, the OCC, and the FDIC each had their own capital ratios and minimums; it took years of analysis and debate among them to decide which measures were most important. (They were Tier 1, total capital, and leverage.) It doesn’t seem to be good regulatory practice to adopt a new during the current crisis.

Thus, there's little reason to put faith in the test or the new standard Treasury plans to use. Nevertheless, here are a few thoughts:

The economic assumptions -- the “stress” in the Geithner stress test will translate into an economic forecast that includes a 10% peak in unemployment rate, a 40% decline (peak-to-trough) in U.S home prices and a recession that lasts until late this year. These are the assumptions that surfaced in the New York Times yesterday. Surprise, surprise, they are also the parameters adopted by JPMorgan Chase for its in-house stress scenario.

Maximum cumulative loss assumptions by loan category over some period -- hopefully the government will adjust these cumulative loss assumptions by institution to account for factors such as loan geography, experience, underwriting practices, pricing, and so forth. If it doesn’t, the output of the test is apt to be arbitrary.

Maximum cumulative loss forecasts will then be measured against an institution’s existing loss reserves, pre-tax, pre-provision earnings, as well as various measures of capital.

Two capital ratios will become the focus. The resulting pro forma maximum income or loss over the test period will then be used to calculate estimated stressed Tier 1 capital and TCE/RWA ratios.

The moment of judgment. For a bank to pass, it will have to show pro forma, stressed ratios above certain minimums. Those minimums are likely to be 6% for Tier 1 capital and 3% for tangible common equity to risk-weighted assets.

The fate of those that fail. If an institution fails to meet either of those two minimums, it will have to raise new capital by some deadline, perhaps April 15. It might raise new equity in a secondary offering, for example. Or, the bank might convert its existing TARP convertible- preferred into mandatory convertible preferred at an exchange ratio based on the common’s price as of a certain date. That date will be important. It's possible it will be the date Geithner first discussed the plan -- when bank stock prices were higher.

If the capital hole still unfilled, the Treasury might require an investment of new capital via a newly issued mandatory convertible preferred with even more severe operating restrictions attached. Any institution requiring the issuance of new preferred on top of the existing preferred will have to replace its CEO.

This table shows the effect that conversion of existing TARP preferred into mandatory convertible preferred would have on 2008 year-end tangible book value per share and tangible common equity to risk-weighted asset ratios of 102 large-bank TARP recipients. Obviously, a full conversion at today’s prices would deeply dilute book value per share. But for most companies, conversion would provide a big cushion to absorb losses uncovered by the stress test.

Again, assuming full conversion of the TARP preferred for all 102 companies -- which will not happen -- this group of banks would see its ratio of tangible equity to risk-weighted assets ratio settle at an average of 10.3%. The group is correctly trading at 1.1 times pro forma book values.

There's reasons for skepticism. The stress test is likely to rely too much on cumulative loss forecasts by loan category and will likely be overgeneralized and too severe. However tomorrow’s disclosure of the test’s details should be good for bank stocks. Why? Because investors are likely to gain confidence in the capital strength of our largest banks and their capacity to weather the most severe credit storms.

We shall see. We shall see. Can the disappearing Treasury Secretary reappear and undo the damage of his last national presentation? Here's hoping there are no more disappointments.

Geithner Drops an O-bomb

Tim Geithner shared his plan for rescuing the banking system. However, the plan he described was not a plan. Maybe it was an outline, and maybe it contained a few worthwhile ideas, but it was not a plan.

He's Obama's man at the Treasury. He's a big force in the new O-conomy. When he carries out Obama's wishes, he drops O-bombs on the O-conomy. This first one may be devastating.

Obama repeatedly hammered the concept of giving federal Stimulus money to "shovel-ready" projects. Obama told reporters Monday night that Geithner would deliver a plan that was ready to operate -- a "shovel-ready" plan, if Obama were to speak in consistent terms.

Instead, Geithner showed his timidity and his inability to tackle the chief issue forming the core of the banking recovery -- valuing the bad assets.

Geithner was petrified at the thought of the government "overpaying" for assets. He said it would take more time to develop a pricing model. After further comments, it was obvious he had no idea how to build his pricing model. He said he wanted input from everyone. Not good.

Obama has repeatedly insisted that acting now and acting fast is the only way to save the economy from catastrophe. But Geithner has shown that the people in the administration who must devise the plans are not capable, and perhaps not willing -- and rightly so -- to spit out a plan in the first weeks after the new administration has taken charge of the government.

It appears Obama is yelling most loudly at Geithner. But not directly. Obama is appearing in cities that have had more than their fair share of financial problems in the last couple of years. He's exhorting everyone to act fast to save our collective neck.

But Geithner offered some vague talk about a government/private partnership to acquire bad assets. After some reflection, it seems this plan is nothing more than a plan of creeping nationalization of the banks.

Meanwhile, the Stimulus Bill was passed. That seems to mean we have committed ourselves to spending $790 billion on a hodge-podge of projects and some tax cuts. The list of projects seem to include funding for every pet project of every politician. But it adds up to a vast expansion of government control over many industries.

Then there is Obama's messianic character. He has begun speaking as though he is delivering sermons from the mountaintop. We are in trouble.

Let the Bank Takeovers Begin

There are over 8,000 banks, almost 2,000 Savings & Loans and 9,600 credit unions in the United States. That's too many. The largest are too large and the smallest too small. Failures occur at both ends of the spectrum. But the costs appear in different ways. Almost no one notices when small financial institutions fail. The cost of failure at the small institutions means nothing to most consumers. But we begin to panic when the huge financial supermarkets crumble, as Citicorp has done.

Fortunately, some of the huge banks have been led by conservative managements. Wells Fargo, for example. The financial crisis has hit Wells, but it will survive because its management stayed away from the activities that have harmed Citi and other financial institutions that have already disappeared.

However, it takes very little to upset the balance at the smallest banks. They are vulnerable due to their insignificant mass. Thus, the industry, consumers and taxpayers will benefit if small banks merge with their local and regional competitors.

In contrast to the US, Canada has six banks. That's it. Just six. Of course the population of Canada is only 34 million, compared with a US population of 305 million. If the US were to adopt the Canadian model, roughly 60 banks would operate here. That's probably too few for optimal service. But we have 20,000 banking companies, which is clearly too many.

Investor Wilbur L. Ross to Buy Majority Stake in Florida Bank

Jan. 16 (Bloomberg) -- Wilbur L. Ross will buy the majority shares of First Bank and Trust Co. of Indiantown, Florida.

The agreement allows Ross to acquire 68.1 percent of the shares in the community bank, subject to regulatory approval, Ross said today in a PR Newswire statement.