Why Bank Of America's Projected Dividend Increase Is Only The Beginning

| About: Bank of (BAC)
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Bank of America (NYSE:BAC) and Citigroup (NYSE:C) are the last two big banks to remain with their diminutive, crisis-induced dividends of one penny per share per quarter. However, with fundamentals improving at BAC seemingly by the day, many are calling for a dividend increase when the Fed's CCAR program results are announced in the coming weeks. One such forecast is from Markit, seeing BAC raising its payout from a penny per quarter to a nickel. While that doesn't sound like much, in this article, we'll take a look at what such a payout would mean for shareholders and what it could mean going forward.

At five cents per share quarterly, BAC's projected dividend would provide a yield of about 1.2% and while this is nothing to write home about, such an increase would signal an important event for BAC shareholders. First, a dividend increase of that magnitude would signal to shareholders that not only is BAC confident in its ability to service such a dividend, but also that the Fed is willing to allow that dividend to be paid. With BAC still in the penalty box from the crisis, this would show renewed confidence in the banking giant, an important step towards normalcy and the days of BAC sporting a nice yield.

In addition, that payout would cost BAC around $2.1 billion per year at its current share count versus the annual expense it is incurring now of $424 million. Certainly, this is a huge amount of money that will be depleted from BAC's books each year but let's see exactly what kind of burden we're talking about. For the full year 2013, BAC produced net income of $11.4 billion, or almost 5.5 times the projected dividend payout. This means that not only can BAC afford a 20 cent annual dividend, but it has plenty of room to grow it. Also keep in mind last year's earnings figure is markedly below what analysts are calling for this year so the projected payout ratio would be much lower.

Using the common payout ratio metric, BAC would be around 12% according to the Markit study linked above given 2014's earnings estimates and projected 20 cent annual dividend. If we put this into the context of JPMorgan (NYSE:JPM), for instance, which pays 27%, we could see BAC substantially raise its payout even further in the coming years. As fundamentals continue to greatly improve at BAC, there is no reason why it can't pay out a quarter of its earnings each year in addition to funding its buyback program. This will return billions of dollars to shareholders and boost overall returns, including share appreciation.

If BAC were to pay out a quarter of its earnings, using 2015 estimates, we could see a payout in the 40 cent range, or 10 times the current payout. That would mean a yield on today's price of about 2.5%. This is exclusive of any buybacks that occur between now and then so assuming we get a 25% payout ratio from BAC, the yield would likely be even higher than that on today's cost. The point is that BAC has plenty of cash after its deleveraging and rightsizing process that has been implemented in Moynihan's Project New BAC; this allows BAC the flexibility to buy back shares at cheap valuations and return capital to shareholders via increased dividends in the coming years.

BAC's expected dividend increases for the coming years would not only return billions in excess cash to shareholders but also signal an important, renewed confidence in BAC from the Fed and itself. BAC's long road to producing a respectable dividend following the crisis appears to be nearing the end as improving fundamentals have left the bank much more capable of servicing a larger dividend. If we get a 25% payout ratio from BAC, which I suspect we will next year or in 2016, BAC would have a yield equal or greater than that of its peer group, as defined by Markit. That would be an important transition for BAC from a growth stock to an income stock, reintroducing shares to those investors that don't want to hold a stock that pays virtually nothing. BAC's future looks even brighter with dividend increases on the horizon.

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.