By Eric Ervin
A consequence of the Great Recession was the Federal Reserve’s annual bank stress tests. Its purpose is to hypothetically impose poor macroeconomic data (declining equity and real estate prices, and rising unemployment) and analyze the impact on participating banks. For 2017, banks with $50 billion in assets or more were subject to both the Comprehensive Capital Analysis and Review (CCAR) and the Dodd-Frank Act stress tests. For dividend-minded investors, these tests are of utmost importance because their results determine if banks have the capital and fundamental health to increase their dividends.
As a hypothetical example, Bank XYZ has a current dividend per share (DPS) of $0.50 and analysts expect a dividend increase of $0.05 (one time DPS increase of 10%) two quarters from now. This bank submits its capital distribution plan to the Fed and prepares for the testing. The Fed approves the plan and the bank announces an actual dividend increase of $0.10 two quarters from now, representing a surprise of 100% (in other words the new dividend amount beat analyst expectations by 100%).
Last year, the resulting dividend increases following the stress test results grew the aggregate S&P 500 dividend by 0.89%. The greatest individual contributors were Bank of America (BAC) and Citigroup (C) with contributions of 0.25% and 0.31%, respectively. Bank of America had a dividend surprise factor of 16.28% and Citigroup had a 49.15% surprise. Many other financial institutions including U.S. Bancorp (USB), American Express (AXP) , PNC Financial (PNC) and BB&T (BBT) all exceeded analyst expectations with their dividend increases.
Morgan Stanley (MS) was the only U.S. company that conditionally passed the qualitative portion of the testing (Source: “Nearly All U.S. Banks Pass Fed’s Stress Test,” New York Times, June 29, 2016). Nonetheless, the Fed still approved Morgan Stanley’s capital plan, allowing for a planned increase in dividends and stock buybacks in later quarters. The company positively surprised and beat analyst expectations with its dividend increase. JPMorgan Chase (JPM) was the sole company with negative analyst expectations (-1.46%); it did not end up cutting its dividend.
The 2017 Results
For this year, analysts expected Bank of America and Citigroup to be the leaders in dividend increases and growing the aggregate dividend of the S&P 500. Bank of America had a projected increase of 33% and exceeded this with an actual increase of 60%, while Citigroup had an expected increase of 25% and significantly beat expectations with an actual increase of 100%, both announced immediately following the release of the results on June 28, 2017 (Source: Bloomberg dividend projections as of June 16, 2017). Along with JPMorgan Chase, these three banks are all increasing the aggregate dividend of the S&P 500 by at least 10 bps, a very significant factor. 20 of the 22 banks in the S&P 500 have announced increases as of June 28, 2017, contributing a total increase of 1.5% the S&P 500 indicated dividend, and 15 of these 20 banks exceeded analyst estimates with their dividend increases. Goldman Sachs and Huntington Bancshares have yet to announce their final capital distribution plans.
DIVCON Dividend Health Rating System
Reality Shares developed the DIVCON dividend health rating system to provide investors with forward-looking dividend growth potential for U.S. dividend paying stocks. The rating system predicts the likelihood of a dividend increase or decrease in the next 12 months. Companies rated DIVCON 5 are considered to be the healthiest dividend payers with the highest potential to increase their dividends in the next 12 months, while those rated DIVCON 1 are the unhealthiest dividend payers with the highest potential to cut their dividends in the next 12 months. The average DIVCON rating of the 22 S&P 500 banks was 3.8 (as of May 31, 2017), well above the S&P 500 index average DIVCON rating. Capital One, which needs to adjust and resubmit its capital distribution intentions to the Fed, is the lowest DIVCON scoring stock in the group (with a score of 46.75, right above DIVCON 2 territory).
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