By Philip van Doorn
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 /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.22% 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 /zigman2/quotes/210599714/realtime SPX +0.93% :
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.
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 /zigman2/quotes/219506813/composite MID +0.61% and the S&P Small Cap 600 Index /zigman2/quotes/210599868/delayed SML +2.19% .
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:
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.
Citigroup /zigman2/quotes/207741460/composite C +1.23% 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: