Bank Dividend: Is It Safe? 2



Banks and Acquisitions This issue of tangible equity raises an interesting question: Why would BB&T pay two to three times the book value of another bank or business to acquire it? Dozens, if not hundreds, of banks are sold on these terms or even richer ones every year, so there must be some logic to it. In accounting terms, BB&T may only be getting 30 to 40 cents worth of equity for each dollar spent on acquisitions, but it isn’t really buying the acquired bank’s equity; what it’s after is the deposits and earnings, including the long-term growth potential of both. BB&T can also cut operating costs by eliminating overlapping back-office and administrative functions.
This doesn’t mean that BB&T or any other bank might not overpay for an acquisition and destroy shareholder value in the process, but in the banking industry (unlike most), well-chosen and well-managed acquisitions can easily add to the buyer’s growth— including dividend growth.

but in the footnotes. Charge - offs . I ’ m not so interested in this figure in any one year, but over a much longer stretch of time. Almost any bank can report low charge - offs when the economy is at the peak of health; I want to know what happens when loans start going bad in greater quantities.
Nonperforming assets . Do these, too, surge in bad times? This may seem a little redundant, since bad loans show up in the charge - off data as well. However, if the bank has to cope with many more bad loans during recessions, future performance is less predictable.
I like to see charge - offs that are low (less than 1 percent on average) and consistent. On both of these counts, BB & T looks solid, especially on the charge - off ratio — just 0.33 percent of the bank ’ s loans have gone bad. (See Figure A3.10 .) This figure has fluctuated with the economy, but the worst year between 1992 and 2006 was just 0.48 percent. Other banks making
riskier loans — in hopes of earning higher net interest margins — can naturally expect higher and more variable charge - off ratios. This can be a profitable strategy, but I ’ d just as soon stick to less - exciting banks with steady credit performance.
Another safety plus is low efficiency ratios. Since most of a bank ’ s noninterest expenses are fixed, a bank with a 65 or 70 percent efficiency ratio will naturally be more sensitive to swings in net revenue than one whose operating costs are just 45 percent of revenue. Efficiency ratios of 50 percent or below generally indicate a bank that actually is efficient, but higher ratios are not necessarily bad for banks that derive large chunks of their net revenue from noninterest income. BB & T ’ s efficiency ratio in 2006 was 53 percent, but with 42 percent of net revenue coming from fee - based sources, high fixed costs certainly don ’ t appear to threaten future dividend payments.
Finally, let ’ s look at BB & T ’ s payout ratio. With a dividend rate of $ 1.68 a share in mid - 2007 and expected earnings of $ 3.33, BB & T ’ s payout ratio comes in at 50 percent. Given the company ’ s prudent lending strategy, this seems like more than adequate protection for the dividend.
I tend to become suspicious when a bank ’ s payout crawls north of 60 to 65 percent. There ’ s nothing necessarily wrong with slightly higher payout ratios, particularly if the bank in question doesn ’ t have many opportunities to expand by retaining earnings; such is the case for Britain ’ s Lloyds TSB Group (LYG), a stock I ’ ve recommended to Morningstar DividendInvestor subscribers. I might also give a bank a break if it ’ s having a bad year, so long as an eventual recovery is reasonable to expect and results won ’ t be bad enough to damage the balance sheet in the meantime. For example, New York Community Bancorp (NYB) had a payout ratio north of 100 percent in mid - 2007, as earnings were squeezed by a rising cost of deposits. Its asset quality is almost perfect, however, and future changes in interest rates should restore the bank ’ s earning power. But for a bank with poor asset quality or a very low equity/ assets ratio, even a low payout ratio isn ’ t going to give me much comfort.