Looking for Dividend Growth in 2021? Read This
Every income investor wants to collect rising dividends, but due to the extraordinary economic environment last year, many companies simply couldn’t deliver. In fact, at the height of the COVID-19 pandemic, most income investors would have been happy if the companies in their portfolios could maintain their payouts. That’s because, with lockdowns, uncertainty, and a recession of historical magnitude, quite a few companies reduced their payouts.
Now though, things look much better. Sure, the pandemic is yet to end, but with a successful vaccine rollout, the U.S. economy should get back on its growth track soon.
And for dividend investors of a particular industry, pay raises should be on the way.
I’m talking about bank stocks.
The banking sector isn’t a particularly exciting one in this day and age. In fact, for several months after the pandemic started, many bank stocks didn’t get much investor attention, even as the broader market was making a swift recovery.
Take a look at the chart below. The green line shows the performance of the Dow Jones U.S. Banks Index while the black line shows the performance of the S&P 500, both starting from the market bottom on March 23, 2020.
Dow Jones U.S. Banks Index vs. S&P 500
Chart courtesy of StockCharts.com
As you can see in the above chart, the S&P 500 was steadily climbing right from the start. The Dow Jones U.S. Banks Index, on the other hand, didn’t gain meaningful upward momentum until November 2020. The banking sector index was able to catch up to the market index eventually, but the relative underperformance earlier on may have made some investors sell their shares of bank stocks too early.
And it wasn’t just the share-price performance that made bank stocks difficult to hold on to. The banking sector is highly regulated, and in June 2020, the U.S. Federal Reserve enacted several restrictions on the sector, including ordering the largest U.S. banks to cap their dividend payments and suspend their share repurchase programs.
In other words, there were strict limitations on how much cash banks could return to investors.
In December 2020, the Fed lifted some of the restrictions. In particular, it would allow the largest U.S. banks to buy back stock in the first quarter of 2021—but dividends would continue to be capped. Moreover, the total amount a bank could spend on its first-quarter dividends and share repurchases couldn’t exceed its average net income from the past four quarters.
There are plenty of banks that had already made a solid recovery by that point. So unsurprisingly, as the Fed lifted some of its restrictions, these companies announced new stock buyback programs. These banks included JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC), and U.S. Bancorp (NYSE:USB), just to name a few.
That may not be good enough, though, because the dividends that many shareholders count on still couldn’t be raised with December’s lifting of restrictions.
The good news is, that could be about to change.
In March 2021, the Fed announced that large U.S. banks that can pass the next round of stress tests would be allowed to resume dividend increases at the end of June. (Source: “Federal Reserve Announces Temporary and Additional Restrictions on Bank Holding Company Dividends and Share Repurchases Currently in Place Will End for Most Firms After June 30, Based on Results From Upcoming Stress Test,” Board of Governors of the Federal Reserve System, March 25, 2021.)
The income-based restrictions on share repurchases will be lifted for the qualified institutions, too.
Given that many of the leading U.S. banks have improved their business substantially in recent months, I’d say that dividend increases are likely on the way for the sector. Investors who were able to hold on to shares of solid bank stocks are already in the green. Dividend increases would serve as a nice bonus.
Final Thoughts on Bank Stocks
Compared to the other high-growth sectors in today’s market, bank stocks may seem a bit boring. However, the idea of banks lending money out at higher interest rates than what they borrow it at has been working for a long time—and it will likely continue to work in the foreseeable future.
In fact, many large U.S. banks happen to be century-old businesses. While bank stocks’ dividends are not carved in stone, the potential for a dividend bonanza this summer—coupled with the current macroeconomic outlook—should make the banking sector worth considering for income investors.