Outlook for bank dividends brightens as US economy rebounds
Income investors will be hoping for increases to bank dividend payments as the next earnings season draws near, now that the Fed’s prohibition on increasing payouts has been lifted.
As we approach the next earnings season, with banks taking their usual place at the forefront of the reporting cavalcade, investors will be hoping that the improving outlook for the US economy will allow financial institutions to increase their payouts to investors.
The Federal Reserve (Fed) suspended the payment of dividends during the height of the Covid-19 crisis, but these restrictions were lifted in March of 2021. The Fed imposed the restrictions in the summer of 2020 during the crisis, in a bid to ensure that banks conserved capital for any further developments in the crisis. It also banned banks from buying back their own stock.
Looking ahead in the second half of 2021 and beyond, it is expected that the US economy will stage a continued recovery. As the number of cases continues to fall and vaccinations become more widespread, the economy should return to a more normal footing. This means consumer and corporate activity should also move back to a higher level, with consumers borrowing more to fund new home purchases and companies looking to engage in mergers and acquisitions (M&A) as well as their bolstering their own borrowing requirements.
Taken together, this should mean that banks will see improvement in earnings and cash generation, and with this should come an increase in dividends. Banks after all are a play on an economic recovery, or on further economic growth, so it makes sense for investors to keep focusing on the sector has the post-Covid recovery moves into a more developed phase. Banks tend to pay out a substantial amount of their earnings as dividends, which makes them ideal names to consider as the economic rebound gathers pace.
As well as the ‘positive’ side of the ledger strengthening, the ‘negative’ side of things should weaken. Bad loans should continue to fall in number, improving the outlook for cash reserves as money previously set aside to cover bad loans is released back into the overall ‘pot’.
Banks have also cut costs, and this will mean that more of the revenue increases should reach the bottom line rather than be swallowed up by costs. The trading side of things should not be overlooked, although after a year when trading was hectic things have quietened down, meaning that the corporate and consumer lending divisions will have to take up the slack.
There are of course risks that need to be considered, and the Fed’s management of inflation and interest rate expectations will need to be watched. A potential ‘taper tantrum’ as markets fret about changes to the asset purchase programme could inject some further volatility into stocks, but the expectation of higher interest rates in due course should help keep the sector in an uptrend over the longer term, since higher rates will help bank profitability overall.
The sector has enjoyed good gains so far in 2021, but while some consolidation would not be unexpected the overall outlook seems to point towards further increases in earnings and dividends, bolstering bank stock prices yet further.
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