When Bank of America (NYSE:BAC) announced what it was allowed to return to shareholders this year, including an increased dividend, it occurred to me that it may be a useful exercise for long-term holders to understand what a "normal" dividend looks like for BAC. That is, what will BAC's annual dividend potentially look like when it is back to operating as it did before the crisis. In this article, I'll take a guess at what BAC's normalized dividend could look like and what it would mean for shareholders. To begin, it would be helpful to estimate what I think BAC could earn on a normalized basis. That is more difficult than it may sound because BAC is still in growth mode following the horrendous years of the financial crisis. BAC's too-big-to-fail brethren, JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC), are already back to normal, earning billions and paying large dividends while buying back stock. BAC is a long way from there so we must use estimates in order to understand what it may look like when BAC finally returns to that status. Also keep in mind that these are estimates and as such, you may or may not agree. I'm giving it my best shot with numbers I believe to be reasonable but I could certainly be proven wrong.
BAC earned just over $10 billion last year and in terms of attempting to normalize these earnings, I'll use return on assets as a basic measure of profitability. The $10 billion last year was earned on average earning assets of $1.75 trillion, good for ~58 basis points of return on average assets. We know from the past decade that BAC ranged in the 1.3% to 1.5% in ROAA prior to the crisis and this means we can use this range as a reasonable guide for normalized earnings. BAC has also been reducing average earning assets since the crisis but has since slowed the decrease dramatically. In light of this information I'll use $1.7 trillion as the steady-state average earning asset level for this analysis.
It could take BAC several years to get back to this normalized level of earnings so we'll take a look at the dividend in the context of 1% in ROAA and then 1.4%, the normalized level before the crash. If we assume BAC earns 1% on its $1.7 trillion we'd be looking at $17 billion in annualized profits. If we assume 1.4% we'd see over $25 billion in annualized profits. While I don't doubt we'll see BAC earn $25 billion per year in the future, it could be a while so we'll go with the $17 billion number for the balance of this analysis.
BAC's current ~10.5 billion shares outstanding means $17 billion in earnings would be $1.62 in EPS. Now, BAC obviously can't pay all of that out but we have some clues as to what BAC would be able to pay from its competitors. This chart from Credit Suisse shows that Wells' and JPMorgan's respective 2014 estimated dividend payout ratios are 33% and 26%. We'll use 30% as an acceptable payout ratio for BAC, meaning that its $1.62 in EPS would net shareholders a 49 cent annual dividend. This would be a yield of 2.8% on today's price and represents a baseline scenario in my view. Given that the payout ratio used is relatively low and that the ROAA number is well below BAC's normalized earnings power before the crisis, I believe there is significant upside. In addition, BAC will begin adding earning assets again after it has completed its massive deleveraging operation of the past few years. All of these things can provide material upside to the dividend. As such, I view the ~50 cent annual dividend as a baseline from which shareholders can expect upside.
If we raise the payout ratio to 35% and the ROAA number to 1.2%, we'd get an annual dividend of 68 cents, or a 3.9% yield on today's price. Using the same numbers but on average earning assets of $1.8 trillion nets an annual dividend of 72 cents, or a 4.2% yield on today's price. Obviously, these are estimates but I find them to be quite reasonable and given that BAC has bettered these numbers handily in the past, there is little doubt it will happen again. The point is that BAC has plenty of room to continue to grow earnings and pay a commensurately higher dividend as well.
In the next few years, as BAC continues to reach a normalized earnings level, I think we'll see its dividend ramp up each year now that the Fed has allowed it to begin returning capital via common dividends again. This year's increase wasn't much but it was an important signal that the Fed thinks BAC is strong enough to be able to return capital to its shareholders in a bigger way. Couple that with BAC's continuously improving fundamentals and you've got a recipe for a $0.50+ annual dividend in the not-too-distant future.
Disclosure: I am long BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.