Bank Dividends Could Soar Following Fed Results

The stock market moved generally higher on Thursday. However, many tech stocks took somewhat of a breather after strong gains in the recent past, allowing some other sectors of the market to lead Wall Street higher.

Investors paid close attention to the results of the Federal Reserve's stress test on banks. With favorable conclusions, many investors who look to financial stocks as sources of generous levels of dividend income are hopeful that they could see payout increases in the days to come. Here's more on what the results of the Fed stress tests were and why some bank stocks in particular are getting votes of confidence from the investing community on Thursday.

The Fed's seal of approval

The Federal Reserve released the findings of its annual bank stress tests late Wednesday. The conclusion it drew was that the banking system in general and large banks in particular are well-situated to handle a severe recession, and that they would be able to maintain healthy levels of lending to both individuals and businesses under tough macroeconomic conditions.

The assumptions that the Fed used anticipated a severe global recession in which commercial real estate prices would plunge 40%, with a substantial increase in office vacancies. Housing prices would plummet 38%, while unemployment would nearly triple to 10%. The result would be a massive drop in economic output.

The Fed's findings were interesting. Even though the 23 big banks subject to testing hold about 20% of office and downtown commercial real estate and would suffer heavy losses of $541 billion overall, they would still be able to continue lending and remain above their minimum capital requirements. Commercial real estate and residential mortgage lending losses were projected at around $100 billion, while credit card losses would come in at roughly $120 billion. The Fed also introduced new tests that looked at the trading books of financial institutions, concluding that rising rates wouldn't be catastrophic for big banks.

Are dividend increases coming?

Now, investors are looking to see how financial institutions will respond to the results. Many of those focused on dividend stocks hope that the banks will follow past practice and approve dividend increases for shareholders.

That would be consistent with past practice. Within days of the 2022 stress test results getting released, Wells Fargo (WFC)Bank of America (BAC)Morgan Stanley (MS), and Goldman Sachs (GS) boosted their quarterly payouts. Increases ranged from modest hikes of around 5% from Bank of America to as much as 25% from Goldman Sachs.

However, investors shouldn't take it as a guarantee that higher dividends will come from all banks. For instance, JPMorgan Chase (JPM) left its dividend unchanged at $1 per share quarterly even after last year's stress tests, as it found capital requirements onerous enough not to want to take chances with a higher payout. Similarly, Citigroup (C) hasn't increased its dividend since 2019, even when it has done reasonably well on stress tests.

Still, bank shareholders seem excited about the news. At midday Thursday, Wells Fargo stock was up 4%, while JPMorgan and Goldman managed 3% gains and BofA and Morgan Stanley picked up 2% each. With the big banks already carrying dividend yields of around 3% to 4%, any further increase would only make the stocks that much more attractive to income-oriented investors.

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