Banking On Dividends From The Financial Sector

financial banksBig U.S. banks are undergoing the sixth round of the Dodd-Frank Act supervisory stress test by the Fed, results of which are expected next week. Under this test, the 30 top-tier banks have to illustrate their capital strength to endure a major economic downturn.

After clearing the stress test, the banks would be able to offer healthy dividend increases to their shareholders. As such, dividend hikes from banking giants are likely to roll in the coming weeks. In particular, three big players - Citigroup (NYSE:C), Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS) are looking for huge increases in their dividends.

According to Markit, Bank of America and Citigroup plan to raise their dividends by 400% each to 5 cents per share. This would translate into a 12% payout ratio and 1.2% yield for the former, and a 3% payout ratio and 0.4% yield for the latter. Morgan Stanley would double its dividend to 10 cents per share, resulting in a 14% payout ratio and 1.4% yield.

Other major banks such as Bank of New York Mellon (NYSE:BK), JPMorgan (NYSE:JPM),PNC Financial Services Group (NYSE:PNC), State Street (NYSE:STT), Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB) would see modest dividend growth in the range of 7%–20% because their payout ratios are already close to the Fed’s benchmark of 30%.

Overall, Markit projects banking dividend growth of 25% for the second quarter compared to the first, should the banks successfully pass the stress test. If the predictions from Markit come true, then it could provide a strong boost to the dividend yields for a number of financial ETFs tracking these banking stocks (see:all the Financial ETFs here).

Below, we have highlighted three ETFs that will are likely to be the major beneficiaries from the dividend increase, any of which could make for a solid play to tap the dividend-paying stocks of the financial sector:

Financial Select Sector SPDR Fund (NYSEARCA:XLF)

The most popular financial ETF on the market, XLF, follows the S&P Financial Select Sector Index. This fund manages about $16.7 billion in assets and trades in heavy volume of roughly 40 million shares a day. The ETF charges 16 bps in fees per year from investors. In total, the fund holds about 83 securities in its basket.


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