With COVID-19 case counts reaching new records in the U.S., it may be difficult to consider an industry whose comeback from the March lows for stocks has lagged behind the broader market.
But for investors seeking income, many bank stocks feature attractive dividend yields that are well-supported by earnings. (See a table, lower in this article, for those companies.)
U.S. banks took their biggest hit to earnings in the pandemic during the first and second quarters. That’s when many recorded large provisions for loan loss reserves, which lowered or wiped out earnings for the first half of 2020. During the third quarter, profitability improved tremendously because the feared spike in loan losses hadn’t begun.
Moving money to loan loss reserves is done in anticipation of credit losses. The strong efforts by the federal government and Federal Reserve to backstop the U.S. economy have helped keep nonperforming loans relatively low. The money that was added to reserves is, for the most part, still there to cover loan losses if credit quality suffers a downturn when collections, foreclosure and eviction moratoriums are lifted.
But income-seeking investors are paying the price. We are now in a “borrower’s paradise” and a “fixed-income investor’s Hell,” according to Mark Grant, chief global strategist for fixed income at B. Riley Financial, who has used those terms in his “Out of the Box” investment commentary repeatedly this year.
Ten-year U.S. Treasury bonds
are yielding 0.93%, while the Bloomberg Barclays Aggregate Index of investment grade corporate bonds has a yield-to-worst of 1.21% and even the Bloomberg Barclays High Yield Index has a yield-to-worst of 4.76%.
Here’s a chart showing how the S&P 500 bank industry group has fared this year, compared to the full S&P 500 Index
The banks have recovered considerably, but still trail the broader market by a wide margin. This sets up a bounce-back play over the next two years, especially if you believe the new vaccines will lead to a return to normal economic activity. And higher-yielding bank stocks will pay handsomely as investors wait, as long as they are not forced to cut their dividends.
Bank stocks to the rescue — carefully selected
Investors with money on the sidelines who mainly seek income might find the risk/reward relationship in the bond market prohibitive. This makes shares of some banks attractive because of relatively high dividend yields and the possibility of rising share prices as the economy recovers in the hoped-for post-pandemic environment.
Looking for liquid, but not large-cap, bank stocks, we began a screen with the 120 in the S&P 1500 Composite Index, which is made up of the S&P 500, the S&P 400 Mid Cap Index
and the S&P Small Cap 600 Index
- Among the 120 banks, 42 have dividend yields of 3.50% or higher, and have not cut their regular dividends during 2020.
- Among those 42, 37 earned enough over the past four quarters to cover their regular dividend payments.
- Among those 37, 25 earned enough during the first two quarters of 2020 (when earnings were affected the most by outsized provisions for loan losses) to cover their dividends.
That last item is an important test. It’s possible that the second wave of coronavirus infections may lead to enough additional economic damage that the banking industry may have another bad quarter or two of extra large provisions for loan loss reserves.
No stock screen is perfect — not even close. But these screens may provide some comfort that dividends are relatively safe, or, for the banks with lower coverage ratios, a warning that a repeat of what happened in the industry during the first half of 2020 could lead to payout cuts forced by regulators.
Here are the 25 bank stocks that passed the above screens, sorted by dividend yield. Explanations for the column headings are below the table. Scroll the table to see all the data:
Notes about the data columns:
- The earnings yields are the past four quarters of earnings per share divided by the closing share price on Dec. 7.
Subtracting the current dividend yield from the earnings yield gives the “headroom” of EPS above the amount paid as dividends over the past four quarters. You can see that the bank with the highest dividend yield on the list, New York Community Bancorp.
had the lowest amount of “headroom.” This does not necessarily mean this bank is the most in danger of cutting its dividend, but a high yield means some investors are concerned that it is possible. The bank cut its quarterly payout to the current 17 cents a share from 25 cents in 2016.
- For the last dividend test, earnings per share for the first two quarters were divided by regular dividend payments. So the ratio had to be at least 100%.
So these banks have not only covered their dividends over the past year, during which three quarters’ results were affected by the virus, their earnings covered dividends even during what were the worst quarters for the industry during the pandemic (at least so far).
If you are considering any of the banks listed above for investment, you should do your own research to learn as much as you can about how they are faring during the pandemic, what risks they face as moratoriums on foreclosures are lifted and what their long-term growth strategies are.
The big six banks
is the only one of the “big six” U.S. banks to make the above list, passing the screens with a dividend yield of 3.51%. Here’s how the rest of the big six club fared in the screen, sorted again by dividend yield:
J.P. Morgan Chase & Co.
has a dividend yield of 2.95%. The bank’s earnings yield for the past four quarters has been 6.29%, for “headroom” of 3.34%. During the first half of 2020, the bank’s ratio of earnings per share to regular dividends paid was 120%.
Bank of American Corp.
has a dividend yield of 2.48%, with a 12-month earnings yield of 6.95%, and “headroom” of 4.47%. The bank’s ratio of earnings per share to regular dividends paid during the first half of the year was 215%.
has a dividend yield of 2.18%. The investment bank’s 12-month earnings yield has been a very high 9.22% for “headroom” of 7.04%.
Goldman Sachs Group Inc.
has a dividend yield of 2.10% with a 12-month earnings yield of 7.27% and “headroom” of 5.17%.
Wells Fargo & Co.
is the only bank listed in this article that cut its dividend during the pandemic, lowering its quarterly payout to 10 cents a share to 51% during the third quarter. The stock’s current dividend yield is 1.36%. Wells Fargo’s earnings yield for the past four quarters has been 1.27%, meaning it would not even have covered dividends at the current level.