The Federal Reserve is expected to release the results of stress test on March 15, triggering investors hopes that the U.S. banks could re-visit their capital distribution strategies via dividend hikes and share repurchases.
Stress Test, or Comprehensive Capital Analysis and Review (CCAR), is a process where financial institutions would be tested to determine whether they have sufficient capital to continue operations throughout times of economic and financial stress. Top-tier U.S. banks with total consolidated assets of $50 billion or more are required to submit annual capital plans for review.
"In general, we expect few surprises as we believe overall results will reflect a still cautious Fed that favors capital accumulation over deployment. As such, we model all-in payout ratios of 40%-60%, with a slight bias towards dividends," Jefferies analyst Ken Usdin wrote in a note to clients.
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Meanwhile, banks will be content with the dividend payout ratios in the range of 20 percent to 30 percent as more than 30 percent attracts additional regulatory scrutiny.
Usdin noted that most banks will only be able to increase their quarterly dividend by 1 cent to 5 cents. On current prices, this would mean another 40 basis point of yield for investors.
On average, the analyst expects banks to pay out 45 percent of total earnings this year, with 25 percent going towards dividends and 20 percent for share buybacks. Overall dispersion should be fairly tight given that most banks seem to be targeting 40 percent to 60 percent payout ratios in 2012.
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"Longer-term aspirations are likely closer to 60%-80%, in our view, but few banks seem willing to push the envelope given that the Fed clearly favors capital accumulation at this juncture," Usdin added.
Most banks capital position are above the minimum 5 percent Tier 1 common ratio and average around 9 percent. This implies that there is excess capital in the system.
"If we assume that banks can manage to an 8.0% Tier 1 common ratio (7% minimum plus some buffer), the average bank in our universe would be able to buy back 10% of shares outstanding," Usdin said.
The analyst said banks best equipped to pay out a higher percentage of earnings this year include Comerica (NYSE:CMA), KeyCorp (NYSE:KEY), Northern Trust Corp. (NASDAQ:NTRS), State Street Corp. (NYSE:STT) and US Bancorp (NYSE:USB).
On a percentage basis, Comerica, SunTrust Banks (NYSE:STI) and US Bancorp to see the biggest increases, while, on a yield basis, Comerica, Huntington Bancshares (NASDAQ:HBAN), and USB to see the biggest increases.
On the other hand, repurchase activity is more of a gray area, given that few banks have given explicit payout hopes.
"We expect most banks to initiate buyback programs in '12, with an average payout ratio of around 20%," the analyst added.
Usdin said banks likely to initiate bigger repurchase programs include Northern Trust, State Street and US Bancorp.