The Real Bank Stress Test

03/18/2013 9:40 am EST


Jim Jubak

Founder and Editor,

While some institutions rated higher than others by the Fed's estimation, MoneyShow's Jim Jubak proposes a different, but likely more relevant test for investors.

The market’s first take on the Federal Reserve’s stress test of US banks has been to divide bank stocks into “naughty” and “nice.”

But I’d like to dive a little deeper, and look at how banks that have been told by the Fed that they can pay out more on dividends or increase their programs of share buybacks have chosen the divide those payout streams.

I think investors get a lot more reward from a dividend increase than they do from a buyback. It makes sense, to my way of thinking, to go with the banks that emphasize dividends over buybacks—all else being equal, of course.

In the market’s first cut on the Fed list, banks such as Bank of America (BAC) that have received the Fed’s stamp of approval on their capital plan for stock buybacks and/or dividend increases have seen their share price move up. Bank of America shares, for example, closed Friday up 3.8%.

Banks that got a thumbs down from the Fed, and will have to resubmit their plans, closed down. BB&T (BBT), for example, finished off 2.36%.

(It’s hard to say that JPMorgan Chase (JPM) closed lower Friday because the Fed told the bank to improve its capital plan. The bank and CEO Jamie Dimon took heavy fire yesterday from a Senate report that ripped the bank’s culture and risk controls in the London Whale trading debacle. JPMorgan Chase shares closed down 1.92%.)

But the banks that got approval to increase their buybacks or dividends have put together very different mixes. Some banks chose to increase their share buyback programs, but not to increase their dividends.

Citibank (C), for example, announced a new $1.2 billion program of share purchases, but kept its dividend at a penny a share. That’s not exactly a rousing vote of confidence by the bank’s management in the bank’s cash flow going forward.

It’s hard—and very visible—to cut a dividend once announced. It’s much easier to announce a big buyback program and then to execute only a part of it if times turn tough. Bank of America was another bank announcing a big buyback—$5 billion—without a dividend increase.

Most of the banks that got the Fed’s approval chose a mix of dividends and buybacks. Banks that wanted to send a message of confidence to shareholders seem to have picked an increase in the neighborhood of 20%. Wells Fargo (WFC) raised its dividend by 20%. US Bancorp (USB) upped its dividend by 18%. Both banks also announced buybacks. (US Bancorp is a member of my Jubak’s Picks portfolio .)

A very few banks went for all dividends. Capital One (COF) is the standout here. The bank announced a 500% increase, to 30 cents from 5 cents.

The financial sector has been a clear leader in the rally to all-time highs in the US stock market. Right now, I’d be looking at bank stocks where management is demonstrating a commitment to taking care of shareholders with higher dividend payouts.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.

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