The Time Is Here: Will Bank of America Raise Its Dividend?

Investors in the nation's second largest lender, Bank of America (NYSE: BAC  ) , have patiently waited for tangible evidence of the bank's hard work over the last three years. Its capital ratios are first rate, it has slayed billions of dollars in legacy legal liabilities, and the bank even recently announced a new marketing campaign designed to repair its tarnished image.

Throughout all of this, however, B of A's dividend has remained at a token $0.01 per share. Is this the year that will change? My guess is "yes," though it must first get the Federal Reserve's approval to do so. On Thursday, we find out if it has.

Will the Fed let B of A raise its dividend?
Of course, the first issue is whether B of A has even asked the Fed for permission to return more capital to shareholders. Since having its 2011 request denied -- humiliatingly, I might add, as its CEO Brian Moynihan had publically stated that the bank would request an increase prior to its denial -- executives at B of A have steadfastly refused to discuss the issue.

The closest Moynihan has come is saying last October that boosting the payout "will be on the table" following this year's stress tests. And as a side note, he went on to state an unequivocal commitment to generous distributions once they are allowed.

"All of the capital we have above the level we need, which is 9 percent, will go back to the shareholders at some point," Moynihan said. "We are done with where we are supposed to be in six years today. If we did not earn a dollar, we would not have to raise another dollar of capital."

Assuming it does ask, in turn, what's the chance that B of A's request will be approved? At first glance, I'd say the chances are good -- assuming, of course, the request is reasonable.

For a bank to obtain approval, according to the Fed, it must demonstrate the "ability to maintain capital above each minimum regulatory capital ratio and above a tier 1 common ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon."

B of A satisfies this handily. As you can see in the chart below, its tier 1 common capital ratio in the third quarter of last year came in at an impressive 11.4%, more than twice the requisite 5% rate. And even after being subjected to the Fed's "severely adverse" economic scenario, in which unemployment spikes to 12.1% by the middle of next year, B of A's core capital remains above the mandatory minimum, coming in at 6.8%.

Source: Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results.

Putting it somewhat differently, on a dollars-and-cents basis, B of A had $76.6 billion of capital above and beyond regulatory minimums at the end of the third quarter. While the excess dropped under the Fed's stressed scenario, B of A still has a $21.5 billion cushion -- click here to read more about how B of A performed in this year's stress test.

The one outlier is B of A's erratic earnings. At the end of last year, Moynihan stressed the significance of this, telling Rick Rothacker of Reuters that the bank needs to prove it can produce consistent earnings in order to gain permission to return more capital.

"The element that is sort of unique to us is the predictability of the earnings stream," Moynihan said. "We are working to get through that."

The biggest drag has been the massive legal liability that it inherited by means of its 2008 acquisition of Countrywide Financial. As I discussed at length in this comprehensive series on B of A's legal problems, the bank has already forked out more than $35 billion to this end, and it could have anywhere between $15 billion and $25 billion more to go beyond allocated reserves -- the latter range assumes a favorable conclusion to this settlement.

The importance and unpredictability of B of A's earnings was underlined in the most recent round of stress tests, the results of which were announced last Thursday -- click here to access our extensive coverage of the stress tests. As I've discussed, under the central bank's most extreme economic scenario, B of A's net income for the nine quarters spanning the fourth quarter of 2012 through the end of 2014, came in at a staggeringly negative $51.8 billion. By means of comparison, the analogous hypothetical losses at the three other too-big-to-fail lenders -- JPMorgan Chase (NYSE: JPM  ) , Citigroup (NYSE: C  ) , and Wells Fargo (NYSE: WFC  ) -- came in at $32.3 billion, $28.6 billion, and $25.7 billion, respectively.

Why'd the bank hypothetically lose so much? According to the Fed's calculations, the $24.1 billion in pre-provision net revenue that B of A would record would be more than offset by $49.7 billion in loan loss provisions -- that is, money set aside to cover future losses from souring loans. An additional $14.1 billion in losses would stem from trading activities, and $13 billion from a variety of other sources.

Suffice it to say, if this scenario came to fruition, then it seems reasonable to conclude that B of A would be in dire need of previously generated capital. This is why Moynihan identified earnings as the potential hurdle to an increased payout.

Come Thursday, then, will shareholders be rewarded with a bigger dividend? Despite the earnings issue, my guess is that they will, but I've be wrong before.

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