Citigroup could be surprise winner in stress tests
(Reuters) - Citigroup Inc may be a surprise winner when the Federal Reserve reveals the results of bank stress tests designed to gauge the health of the biggest U.S. banks.
The third-largest U.S. bank may receive permission to increase its penny-per-share quarterly dividend, analysts say, something long-suffering shareholders have been waiting for since the payout was slashed after a series of government bailouts.
Stronger banks such as Wells Fargo & Co are also likely to see another round of dividend increases, while Bank of America Corp and other banks still trying to rebuild their capital, such as Regions Financial Corp, will be left out.
The results, expected by Thursday, could boost stock prices for some banks, and undercut this year's appreciation for others, analysts said.
Analysts generally expect banks to pass the tests, which are meant to show how they would perform in an economic crisis. But investors will be closely watching how generous the Fed is in allowing banks to increase dividends and repurchase shares.
Bank stocks have surged so far this year, with the KBW Bank Index climbing 16 percent. But investor sentiment could get a reality check from the results, said Sterne Agee analyst Todd Hagerman.
The Fed is seen being more conservative than it was in 2011 in approving dividend increases and share buybacks. Regulators continue to worry about the health of the financial system, the global economic outlook and future earnings growth, he said.
"Given that conservatism, I think it's premature for these companies to be thinking about releasing so much of the hard-earned capital they accumulated such a short time ago," Hagerman said.
Banks whose shares could be boosted by the results include PNC Financial Services Inc, Fifth Third Bancorp, Wells Fargo, BB&T Corp and US Bancorp, Hagerman said.
On the other hand, Bank of America, SunTrust Banks Inc, KeyCorp and Zions Bancorp could see their stocks negatively affected.
In this year's version of the stress tests, the Fed is once again examining 19 large banks to determine whether they would be able to maintain a sufficient level of capital in a worst-case scenario that includes 13 percent unemployment. In addition, the Fed is also subjecting another 12 banks with assets between $50 billion and $100 billion to less stringent reviews. Unlike last year's tests, the Fed plans to publicly disclose details of how the banks performed.
In its instructions to the 19 banks, the Fed said it expects capital plans submitted by the financial institutions to reflect "conservative common dividend payout ratios." Payout ratios of more than 30 percent of earnings will receive "particularly close scrutiny," the central bank said.
A Fed-approved dividend increase would be a significant stamp of approval for Citigroup, one of the most damaged financial institutions during the financial crisis. The New York-based bank could raise its quarterly dividend to 10 cents a share from its nominal level of a penny, according to some analysts.
"We think the market is still underappreciating (Citigroup's) capital return potential," Oppenheimer analyst Chris Kotowski said in a recent report. Citigroup has the greatest potential of the major banks of positively surprising Wall Street, he said.
Stock buybacks could also be ahead for Citigroup.
"Some of our peers were buoyed by the ability to buy back shares, an option we lacked," Chief Executive Vikram Pandit wrote in his letter to shareholders in Citi's 2012 annual report, released last week.
"In the final analysis, the value that we all want to see reflected in our share price will be most apparent when we can meaningfully return capital to shareholders," wrote Pandit.
Nomura analyst Glenn Schorr said a dividend increase for Citigroup would be a sign that the company is getting control of its balance sheet and starting to build capital. The company still has work to do to finish cleaning up its mistakes, he said.
To be sure, Citigroup will still trail its other big bank peers significantly in returning capital to shareholders.
According to Raymond James analysts, Wells Fargo could get the go-ahead to increase its annual dividend to 72 cents per share from 48 cents, while JPMorgan Chase & Co may get permission to go to $1.30 from $1. Both banks are also expected to buy back more shares.
Bank of America, though, will not be among the banks boosting payouts.
After the Fed denied its request for a dividend increase last year, the bank's executives did not ask to raise its penny per share dividend or buy back shares. Instead, the bank in the past year has focused on improving its capital measures by selling non-core businesses, shedding risky assets and improving earnings.
Last year's rejection was an embarrassment for CEO Brian Moynihan and highlighted the challenges the bank faced in recovering from its 2008 Countrywide Financial acquisition, which saddled the bank with mortgage-related loses and lawsuits.
Bank of America finds itself in a "no-man's land," in which it has no need to raise fresh capital by selling stock to investors but it trails its peers in meeting new international capital standards, said Marty Mosby, bank analyst at Guggenheim Partners. The bank should meet these so-called Basel III standards before a fully phased-in date of January 1, 2019, but other banks will get there faster, he said.
An important thing for investors to watch in the results will be the Fed's determination of the bank's potential mortgage losses, Mosby said. One of the key questions about the bank is how much it will ultimately have to pay to cover requests by investors to buy back soured mortgages the bank sold them during the housing boom.
Among other major banks, Goldman Sachs Group Inc executives have not indicated whether they have asked for a dividend increase or the ability to buy back more shares. After last year's tests, Goldman redeemed shares held by Warren Buffet's Berkshire Hathaway Inc.
Morgan Stanley has said it is focused on increasing the firm's investment in its Morgan Stanley Smith Barney brokerage joint venture.
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