Beware banks bearing large dividend yields as one-time hits to earnings keep coming

Shareholders are finally looking forward to a reward for buying beaten-up European bank stocks.

Lenders have shrunk balance sheets, bolstered capital and shunned complex risk — all while promising bigger dividend payments.

History suggests investors will yet be disappointed.

Consensus expectations surrounding dividends haven’t been this feverish for a long time: The dividend yield on the Bloomberg European 500 Banks Index has climbed to 6.5%, the most in almost five years.

It’s also nearly a percentage point more than the yield from the region’s boringly reliable insurers.

Simply put: Banks have more capital, are starting to generate more profits and have promised to return a greater proportion to investors — and dividend yields are reflecting that expectation.

The correlation between valuations and dividend yields or payout ratios has grown stronger in recent quarters as lenders near or exceed their capital targets.

But there are warning signs.

The one-time hits to earnings keep coming.

Royal Bank of Scotland this week announced £3.6 billion (€4.7bn) of charges for matters ranging from litigation to customer compensation — prompting JP Morgan analyst Raul Sinha to cut his capital return expectations on the stock by 40%.

Lloyds may follow with more charges that will limit the bank’s scope for paying dividends, according to some analysts.

Nordea’s shares plunged this week after the head of Scandinavia’s biggest bank said it was wrong to promise a payout ratio of “at least” 75% of profits.

There are more red flags elsewhere.

While banks are expected to report increased earnings, at least according to consensus estimates, dividend futures are much less bullish.

The Eurostoxx dividend futures index has dropped since mid-August — not just because the decline in the oil price will cut into that industry’s dividends but also because of concerns about the banks, according to Edmund Shing, a derivatives strategist at BNP Paribas.

To be sure, some banks are paying dividends. After a gruelling overhaul, UBS delivered a special dividend for last year, while ING, the bailed-out Dutch bank, has paid its first dividend since the crisis.

In the UK, banks produced £10.8bn in dividends last year, 22% more than in 2014, according to Capita. Life insurers paid out £3.6bn, a far less racy increase of 4%.

That comparison with insurers is important: They simply have a more reliable track record of earnings and dividends than banks.

Banks are still in a fog of confusion surrounding regulation and litigation. Some lenders have increased their payout ratios over the past five years, while insurers’ have barely budged.

But that’s not a wholly healthy sign for lenders.

The ingredients for a sea change in bank dividend payouts aren’t there yet.


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