A while back, I wrote an article that talked about how I thought Bank of America (BAC) stock was a buy ahead of a potential dividend increase that could be coming shortly. My theory was that once the company was able to satisfy the government's capital adequacy requirements and further strengthen its balance sheet, the next logical move could be to restore the dividend. After all, a returning dividend could be a show of financial strength to investors and Wall Street analysts that could be the boost that starts sending the stock price higher.
Well, the results of the Fed's Comprehensive Capital Adequacy Review came out and Bank of America did very well but then something happened. The company opted to keep the dividend at $.01 per share and instead invest its extra capital in repurchasing its own shares in the open market.
The move makes logical sense too. Bank of America's shares are pretty cheap at the moment by most valuation metrics (something I also discussed previously here) and buying back cheap shares is a quicker way to deliver immediate value back to shareholders.
I certainly don't disagree with BofA's decision to execute the stock buyback but as an income investor it makes me wonder just when is that dividend increase coming if at all?
A few months ago, my answer would have been "soon" and pointed to the release of the Fed's stress testing results as a likely final hurdle to announcing a dividend increase. Today, I think that a dividend increase may not come for a while - perhaps not until 2014 or later - and I think there's a few pieces of evidence pointing me in that direction.
First, there's the recent precedent set by Brian Moynihan and his management team. Moynihan stated as far back as October of last year that a payout to shareholders was on the table and pointed specifically to the Fed stress tests as a likely time to make the move. He reiterated his stance again in January saying that "the capital is there" and that they just needed to get through the Fed process first. Once the Fed announced that BofA had officially passed the tests, the company opted against raising the dividend at all and chose instead to go with the aforementioned stock buyback of over $10 billion.
If management felt that this was the best course of action to return value to shareholders in March, I feel little reason to believe that they're going to change course over the next 12 months. As mentioned above, Bank of America stock is cheap right now trading at about 63% of its current book value [compared to around 74% for Citigroup (C), 96% for JPMorgan Chase (JPM) and 136% for Wells Fargo (WFC)]. As long as the stock remains that undervalued, management should continue focusing on share repurchases as a means of returning capital to shareholders and I think they understand that. If the stock rallies and the price/book ratio begins rising to less competitive levels, I can see Moynihan reconsidering the dividend strategy but not until that point.
Second, I believe that the company wants to feel a little more comfortable in the future of its capital position prior to committing to a significant dividend going forward. As much as Bank of America's financial position and capital ratios have improved, there's still potentially tens of billions of dollars in loan losses and reserves related to the Countrywide acquisition that it may still have to address.
If the company decides to raise the dividend, it'll probably raise it enough to bring the yield to 2% or more. Anything less I think just doesn't move the needle enough to make a difference. If the payout gets raised from $0.04 per share annually to, say, $0.28 per share (putting the yield at around 2.2%), that would amount to an annual dividend payout of over $3 billion per year based on the current number of shares outstanding. With a capital position north of $70 billion, that doesn't seem like a big commitment but in the face of the Countrywide-related loan losses, it could be enough make the management team want to hold off for now.
For the record, I think Bank of America will eventually get the dividend yield back up to around the 3% range. After all, prior to the housing collapse the bank had a stellar track record of paying and raising the dividend on a regular basis. I think they'll get back to the point within the next year or two but only when the prospect of share repurchases becomes less financially attractive.