By definition, income oriented investors look first to at least a respectable yield, and hopefully, one that grows over time, via dividend increases. Historically, banks figured prominently in such portfolios for good and obvious reasons. They enjoyed good cash flows, and profits tended to grow with the economy. After all, “borrowing cheap, and lending dear” hardly qualifies as rocket science. Barring malfeasance, gross incompetence, or an economic “Act of God”, it's pretty tough to screw up a bank. Maybe the banker down the street will run his institution more efficiently, and profitably, but aside from the examples just given, banks rarely go bust.
Of course, the landscape for banking changed dramatically as a result of the Great Recession, and the dividends that income investors salivate over were either eliminated, or at the very least, slashed to the bone. The largest banks that attracted the most income investors by virtue of being large, and arguably the safest, have suffered the most, for reasons known to all.
For some time, talk has been circulating that the worst is over for the banks, and better days are pretty much right around the corner, meaning a restoration of dividends, and presumably a resumption of the growth of those dividends. No less a “hero” among the big bankers than Jamie Dimon has publicly stated his intent to restore JPM’s dividend at the earliest possible time (something that he’s said on more than one occasion). He wasted no time in repaying TARP funds to get out from under the Federal government’s thumb; certainly a laudable action. If there’s a “White Hat” to be placed on the head of any of the big bankers, it arguably belongs firmly on his head.
It's my opinion, however, that the “happy days” are still way off in the distance. Let’s look at some of the headwinds that the big banks will face in attempting to restore, and then raise dividends. First, there’s the effect of financial reform that forces the big banks to divest themselves of prop trading operations. For more than a few years, a nice chunk of bank earnings came from such activities, but that would appear to no longer be the case. I grant that there might be some wiggle room in the wording that might allow for some amount of trading on a client’s behalf, but the glory days are over.
Secondly, we have increases in Tier 1 capital being mandated to help buffer future losses. The increases will come via either increased retention of profits, and/or share issuance (aka “dilution”). In all likelihood, it will be some of both. Many of the “improved” earnings posted by the big banks were the result of cutting back on loan loss provisions, but that was before “foreclosure moratorium”. While it's still far too early to assess how badly banks will be affected, my guess is the outcome will fall into the range of “bad” to “absolutely horrible”.
Last, but not least, I ran across this little tidbit in Reuters. The Boston’s Fed Eric Rosengren, speaking at an event at the IMF’s meetings last weekend, suggested that a “more proactive supervisory policy forcing banks to cut dividends in time of stress may shield the economy from future credit shocks”. According to the article:
Clearly a proactive approach to dividend retention could have substantially reduced the need for an emergency infusion of public funds...Regulatory policy should prompt supervisors to look forward and thus more proactively seek reductions in dividends in appropriate circumstances
Now, I think it entirely possible that there may well be some small regional banks that still offer an attractive investment opportunity, but it will call for more than a bit of digging to unearth them; time that might be better spent looking in other sectors entirely. Another option is to look at overseas banks. I’m not speaking of EU banks, which are arguably in as bad, if not worse shape than US banks, but rather banks in emerging markets. Of course, that begs the question if such investments are in keeping with a “conservative” mandate.
Disclosure: No positions