Are Bank Dividends Safe Following Fed Stress Tests?

Bank stocks have taken a hit with the forced economic shutdown. And already big banks have cut their share repurchase programs. Some investors are now worried about the bank dividends, and for good reason.

The government has helped prop up the economy but loan losses are still expected to soar. This is putting pressure on the financial sector. And with the 2008-09 financial crisis in recent memory, the Fed has stepped up its stress tests...

Bank Dividends At Risk From Fed Tests

If you’re looking for dividend growth, the Fed put a stop to big bank dividend increases. This action from the Fed earlier last year isn’t a result of standard annual stress tests. Instead, the Fed had a separate review of coronavirus impacts on the economy.

This uncovered potential risks that led to the dividend pressure. The Fed has been using a new formula based on recent earnings to limit future payouts. And in a few cases, like Wells Fargo, this has already prompted a big dividend cut...

On July 14, Wells Fargo Co WFC announced a cut from $0.51 to $0.10 per share. That’s just over an 80% decrease. And some other big banks might follow suit...

“If the Board suspended the dividend, it would be out of extreme prudence and based upon continued uncertainty over what the next few years will bring.” – Jamie Dimon, JPMorgan Chase CEO

Although, JP Morgan Chase & Co JPM reported much better numbers than expected in Q2 2020. Revenue came in close to $33 billion. The bank’s trading revenue helped lead to its highest quarterly revenue ever. Then in Q3, revenue came in slightly lower but it beat analyst expectations again.

Still, there’s a lot of uncertainty around the global pandemic and the Fed continues to explore potential risk. Already, there are more assessments on the horizon. And for other big banks, this might lead to new proactive dividend cuts.

For income investors living off dividends, this isn’t a great sign. To see how this impacts your portfolio’s growth, you can use this free Investment Calculator. It’s an easy-to-use tool that can show a breakdown of your projected returns each year.

And although there’s stress on the financial sector, this short-term pain in the financial sector is creating new value opportunities. If you’re able to weather lower dividends in the short-term, owning bank stocks might show higher capital gains down the road – plus a return to higher dividends.

Bank Stocks Are Safer This Time Around

Fear is high and investors have beaten-down bank stocks...

During the start of the pandemic, the Financial Select Sector SPDR Fund XLF had dropped more than 40%. And since, it’s rebounded with the broader market but not as much. The S&P 500 is up close to 10% from pre-pandemic highs and the financial sector is still down about 10%.

But are the lower valuations in the banking industry justified? Probably not... since the past financial crisis, the big banks are much safer. And the current crisis isn’t as much of a balance sheet issue. Instead, it’s an issue of expected earnings.

In its latest round of stress tests last month, the Fed signaled they will easy restrictions on buybacks. Though they kept dividend limits in place, there's reason to think the central bank will list those limits as we come out of this crisis. 

There’s also another big name that has pointed out the value opportunity in big bank stocks...

Flipping from Betting Against to Buying U.S. Bank Stocks

In the Michael Lewis book, The Big Short, Steve Eisman was one of the main characters portrayed. Against many naysayers at the time, he bet big against Wall Street before the housing bubble collapse.

Steve Eisman has been critical of Wall Street and the big banks. But now, he believes they’re in much better shape...

“Post the great financial crisis of 2008, the regulatory apparatus spent years working on the banks… the banks were forced to de-lever and to wield multiples more liquidity. Now that we have a second crisis, the banks are fine.” – Steve Eisman

He’s done a 180 and said earlier this year that long-term the large banks might be the best cyclical plays. And based on his track record with bank valuations, that might be a great sign for long-term investors.

Overall, in the next year or two it’ll be tough for most banks. But the economy will recover as it always does. And the big bank stocks aren’t going away anytime soon. So, you might want to consider scooping up some shares at a discount.

To find more investing opportunities, check out these other dividend related articles.