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We wrote last January that in 2011 increased bank dividends would emerge as a new investment theme, one likely to push market valuations higher. We predicted that 7 of the largest 19 U.S. banks were likely to raise their common dividends, once the Federal Reserve completed its latest stress test of their capital sufficiency and reviewed their respective capital plans.

On Friday, in the first easing of regulatory oversight since the financial panic of 2008, the Fed announced approvals that were more accommodative than we dared hope, to payouts (in combinations of dividends and stock repurchases) to about 30% of earnings, well above our expected 20%. Notably, it approved increased dividend requests of banks that have yet to repay their TARP obligations.

Cumulatively, banks received approval to increase their dividends by more than $8.7 billion. Total dividends will likely exceed $12 billion this year, more than the $7.9 billion earned by all U.S. banks in 2008.

We had expected seven banks would request and be approved to raise their dividends. All did, except Capital One (NYSE:COF). JPMorgan Chase boosted its quarterly dividend to $0.25 from $0.05 and announced a $15 billion share buyback, of which it authorized $8 billion for 2011. Wells Fargo (NYSE:WFC) increased its dividend to $0.12 from $0.05 and announced a $200 million share buyback authorization. US Bancorp (NYSE:USB) hiked its dividend to $0.125 from $0.05; its board authorized a $1.35 billion, 50 million share buyback.

Both Bank of New York Mellon (NYSE:BK) and PNC Financial Services (NYSE:PNC) announced that the Fed approved their respective capital plans, with specific actions pending their boards’ meetings in early April. State Street (NYSE:STT) increased its dividend to $0.18 from $0.01.

Though COF requested no dividend increase, there was a sound basis had it requested one. It earns about $1.50 per quarter, but pays a $0.05 dividend (compared to $0.375 pre-panic). It repaid its TARP obligation in the first wave without having to raise additional capital.

However, a 2010 rule change pertaining to accounting for off-balance sheet credit card securitizations will impact the company’s capital ratios through this year’s third quarter. More positively, having indicated that 1Q2011 is likely the trough in credit card receivables, COF appears to anticipate a rapid increase in outstanding credit card loan balances, which would boost net interest margin, average earning assets, revenues, and earnings. Capital retention will support rapid growth. If the growth doesn’t materialize, dividends can be raised in future quarters.

Not on our list of dividend raisers were BB&T (NYSE:BBT) and Fifth Third (NASDAQ:FITB). BBT announced a penny increase to $0.16 from $0.15. Given that BBT earns between $0.27 and $0.33 per quarter, we viewed their payout ratio as already high relative to peers and perhaps too high for the Federal Reserve’s taste. It wasn’t. At the time of our January analysis, FITB had not repaid its TARP obligation, but did so in subsequent weeks. After approval of its capital plan, its board will consider raising its quarterly dividend at its meeting on March 22nd.

Similarly, KeyCorp (NYSE:KEY) announced Friday that it received regulatory approval to repay TARP, and approval, too, to increase its dividend to $0.03 from $0.01 following repayment. We expected that the Fed would delay approving dividend increases for banks still holding TARP as of 2010-end, given that the first companies that exited TARP in May 2009 waited over 18 months ro approval to increase their dividends. It didn’t. SunTrust (NYSE:STI) also announced plans to repay TARP, but was silent on a dividend increase.

As welcome to investors as these dividend increases are, the more important news is that the Fed’s actions, on balance, signal clearly that our banks are again “safe and sound”, having largely recovered from the financial panic of 2008. The Fed’s greater accommodation, borne of its recognition of the industry’s growing strength and the limitations of its regulatory role, suggests that the valuation benefit will be greater than the market has anticipated.

Source: Fed's Bank Dividend Approvals Should Help Stock Valuations