Big Dividend Increases Coming To These 3 Blue Chip Banks

Positive results from the Fed’s stress test have allowed three major banks to increase their dividends and share buybacks dramatically, up 220%, 50%, and 33% respectively! These big increases bode well for the total return potential of these three banks. Our recommendation, buy shares now.

The last week has produced news at the opposite extremes for British banks compared to their U.S. based counterparts. For the UK banks, the Brexit vote to leave the European Union turned their fortunes from positive to negative. Just a few days later, the U.S. Federal Reserve issued a report that allows some of the major U.S. banks to significantly increase their dividend payments.

The vote by the citizens of the United Kingdom to leave the European Union may end up having the greatest negative effect on the major British banks. With Britain as a member of the EU, London had become the primary banking center for all of Europe. Now, with the requirement to renegotiate the financial ties between the UK and EU, the British banks could lose a lot of clout and profitability. A prime example is Barclays PLC (ADR) (NYSE: BCS), which has a share price that is now 30% below the closing value on June 23 before the vote results were known. In general, European and U.S. stocks have recovered most of the declines driven by the shock of the vote to leave the EU. The stock values of the London banks have not participated in the recovery. It may be years before the actual effect of the vote on the banks is truly known.

On the U.S. side of the Atlantic, the Federal Reserve over the last week released the results of its annual stress tests of big U.S. banks. The tests are a review of the capital plans submitted by the individual banks. The Fed is looking to see if the banks can weather a significant economic recession. The ability to pass the test depends on if a bank has sufficient core capital.

If the bank passes the stress test, the Fed tells them how much excess capital it currently has, and that excess can be used for other purposes such as paying dividends or buying back shares. In its report, the Federal Reserve cleared 31 of 33 large banks to use excess capital reserves to boost returns to investors.

The large U.S. banks received approval to boost dividends on average by 10%. Each year, the major banks must submit their capital plans and pass the Fed’s stress tests. When the report releases, the passing banks are allowed to increase the cash paid to investors. Here are a couple of large banks that will significantly increase the cash returned to investors.

Citigroup Inc. (NYSE: C)increased its dividend to $0.16 per quarter, up from $0.05 and a 220% increase. The bank has also announced it will buy back $8.6 billion dollars of stock or about 7% of the outstanding shares. The buyback will leave more cash per share for a higher dividend when next year’s stress test results are announced. C yields 1.5%.

Bank of America Corp (NYSE: BAC) increased its dividend by 50%, from $0.05 per share per quarter up to $0.075. B of A is also going to buy back $5 billion of common stock, which is about 3.5% of the outstanding share amount. BAC yields 2.25%.

Morgan Stanley (NYSE: MS)increased its dividend by 33% to $0.20 per share, up from $0.15. This bank has announced its share buyback will total $3.5 billion or 7% of its share float. MS now yields 3.1%.

Over the last year, the big money center banks like these three have produced losses of 20% to 30% for investors. The stress test results that let them significantly boost dividends and use capital to buy back shares should turn around those negative returns going forward. While the dividend increases for next year depend on what the Fed allows, the current capital structures of these banks point to similar if not larger cash increase to dividend payments a year from now. The expectations of higher dividend rates and continued share buy backs should promote higher share prices starting now.

Another result of the Brexit vote will be the continuation of the Fed’s low-interest rate policy. The Federal Reserve Board will not want to add additional uncertainty into the economy with the potential for higher interest rates. Britain’s main central banker stated that rates in the UK will be lowered to make sure the economy there stays stable.

The low-interest rate environment bodes well for high continued total returns from real estate investment trusts, and I expect REITs to outperform the banks for both yield and total returns. As an alternative to the big banks for dividends here are three REITs that provide higher yields and greater diversification:

Easterly Government Properties Inc. (NYSE: DEA)is a growth focused REIT that owns facilities leased to federal government agencies. With Uncle Sam as its renter, the DEA 4.7% yield is very secure. The company actively acquires new contracts to grow owned assets and also grow the dividend. The DEA dividend has increased by just over 100% since its February 2015 IPO.

Communications Sales & Leasing Inc. (Nasdaq: CSAL)is a fairly unique REIT whose primary assets consist of fiber and copper communication lines. Those lines are leased on long-term contracts by telecom companies that provide phone and Internet services. CSAL currently yields 8.2%. CSAL has increased its dividend by 33% since July of 2015.
 

Starwood Property Trust, Inc. (NYSE: STWD) originates and holds a portfolio of commercial property mortgages. This REIT competes directly with the major money center banks. Compared to the big, regulations tied banks, Starwood can be much more flexible in tailoring its loans to fit client needs. STWD currently yields 9.3%.