Archives for March 2012

The real winner in last week's bank stress tests should have been the shareholders.

But after the stress test results on 19 top financial institutions were announced last week and all but four of them passed, shareholders with bank dividends were left wanting more.

Of course, the more successful banks – like JPMorgan Chase & Co. (NYSE: JPM) – did announce modest dividend increases, and large share repurchases immediately afterwards.

The problem is they didn't go far enough.

Even now, after these increases, bank dividends still remain far below the level of 2007 in many cases, and represent only around a quarter of net income.

For bank shareholders, that makes no sense.

I'll tell you why.

The Case for Higher Bank Dividends

The great majority of bank shares in the United States are commercial banks, which take deposits from customers and lend money to businesses.

That is an intrinsically low-risk business, unless the bank is lending recklessly.

In addition banks provide credit card and other services to consumers and businesses, all of which are relatively low in risk.

They are also slow-growth, since the U.S. economy grows only 2-3% per annum on average. Being slow-growth, low-risk businesses, banks do not need to grow their capital rapidly.

Of course, bank services did grow faster than the economy from 1980-2007, but that is every reason to think that was something of bubble, and that much of the excess returns available to banks in those years is now gradually washing out of the system.

As a result, banks can afford to pay a high percentage of their earnings in dividends – perhaps as high as 70-80%.