Big Bank Payday
For years, the Federal Reserve has been the bitter enemy of U.S. savers.
After all, the Fed’s zero interest rate policy (and minuscule recent rate increases) have led to paltry returns on savings accounts, withering pension plan balances, and hardship for retirees.
But this week, the Fed made a completely unexpected decision… One that was largely overlooked by the media… And this decision gives savers like you and me a chance to boost income payments by 60% or more!
Let’s dig in to this overlooked Fed decision so you can claim your share of this income…
Banks Pass Fed’s Stress Tests, Gear Up For Bigger Payments
This week, the Federal Reserve announced that all 34 banks passed the Fed’s annual stress test. That’s big news considering it is the first time all participants have received passing marks since the Fed first started administering the tests in 2011.1
A passing grade simply means that banks have enough capital to weather a financial storm. For instance, one of the scenarios the Fed uses is a recession in which real estate markets have severe challenges, corporate loans default and the unemployment rate reaches 10%.
On the surface, it’s encouraging to see that U.S. banks have finally made enough responsible decisions to be able to withstand a challenging market environment.
But strong banks by themselves aren’t going to do you and me a bit of good. Because after all, savings accounts are still paying paltry rates of return.
Fortunately, there was a second part to these stress tests that caught my eye. One that will lead to bigger income payments, and much higher investment returns…
And these returns tie back to the Fed’s stress tests and the capital these banks have set aside.
You see, part of the stress test process includes bank requests to pay capital back to shareholders. Essentially, the banks tell the Fed how much they would like to spend on dividends and share buybacks, and the Fed gives them a green light — or a red light — to follow through on the plans.
This year, all 34 banks also received a green light to increase payments to shareholders. And we’re not talking about a small increase either.
According to the Fed’s statement, U.S. banks now have approval to pay as much as 100% of this year’s earnings back to shareholders. That’s up from a 65% level approved last year.2
Banks will return this capital to shareholders using one of two methods (or both):
- Banks can increase dividends paid directly to shareholders
- Banks can also buy back shares of their own stock.
Both of these types of payments work to our favor.
If you own shares of a bank and the dividend increases, that means you’ll get a bigger payment every quarter. And if you’re enrolled in a Dividend Reinvestment Plan (or DRIP), the bigger payments will help you buy more shares of your bank stocks.
As the power of compound interest kicks in (earning ever-growing payments on more shares of stock), your account will grow exponentially.
Banks buying back shares of their own stock also helps investors.
You see, when banks spend capital to buy back shares, it reduces the number of outstanding shares that are available. This way, a bank’s future earnings are spread out among fewer shares, leading to higher earnings per share.
Of course, with higher future earnings per share, bank stocks will naturally trade higher. And future dividends will also increase. As long as banks pay an attractive price to buy back their shares, it’s still a great deal for investors!
Get Ready for Fat Dividend Checks Headed Your Way!
Now that the major U.S. banks have passed their annual stress tests, and received clearance from the Fed, big changes are about to happen.
For instance, Bank of America (BAC) immediately announced that the company is increasing its dividend by 60%.3 The new quarterly dividend is 12-cents per share, giving investors a 2% dividend yield.
That yield should continue to increase as earnings grow and the number of shares declines.
Speaking of shares, Bank of America also authorized a $12 billion share repurchase program which will take place over the next year. Buying these shares will naturally drive the price of BAC higher. And it will also set the stage for higher dividends in the future (as earnings are spread between fewer shares).
As more banks announce plans for dividend hikes and share buybacks, I expect the financial sector to trade higher. As an income investor, you’ll want to make sure you buy shares before this rally occurs, so you can participate in both the higher dividend payments, and the investment gains from stocks trading higher.
Over the next few weeks, I’ll have more to say about the banking industry and the Fed’s stress tests. For instance, I want to tell you more about why the Fed’s decision this week should actually improve the health of our financial system and lead to more jobs and higher wages.
In short, I’m extremely critical of the Fed’s interest rate decisions which have hurt U.S. savers. But this week’s decision to allow banks to pay bigger dividends will make things easier for savers who know how to take advantage of these investment opportunities.
Here’s to growing and protecting your wealth!
Editor, The Daily Edge
1Fed ‘Stress Tests’ Clear All Banks to Issue Payouts to Shareholders, WSJ, Liz Hoffman
2Big Banks Set to Pay Out Largest Dividends in a Decade, NYT, Michael Corkkery
3Bank of America Announces Increases to Quarterly Common Stock Dividend and Common Share Repurchase Program, Bank of America