"Many banks will soon start increasing their dividends!"

This is the starting forecast of Harry V. Keefe Jr., chief executive officer of Keefe Managers Inc. and a dean of the bank analyst fraternity for over 40 years.

In a banking world of losses, writeoffs, and ever-increasing demand from the regulators for more capital, how can Harry Keefe make such a statements?

Harry looks at the numbers.

The average equity to assets ratio of 25 major banks has risen from 5.84% in 1991 to 6.94% in the second quarter of 1992.

Strong Capital Positions

How did this happen?

First there were the large capital issues that augmented bank equity positions. Then earnings rose sharply, with net income of the 25 largest banks rising 50% from the second quarter of 1991 to the second quarter of 1992.

Throw in the downsizing of the banking industry, and it gives stronger capital positions than at any time in 30 years.

Earnings Expected to Surge

What is more, as Mr. Keefe points out, earnings increases should be strong. Why?

* Banks are pushing for efficiency. CEOs who didn't even know what an efficiency ratio was a couple of years ago are fighting daily to improve theirs now.

* With the thrift industry in its present difficulties, banks are not being forced to pay high rates to compete for savings.

* When bans do need funds for loans, they are more likely to sell low-yielding investments rather than bid up the rates paid on savings. So money is cheaper than at any time since the late 1950s for banks to buy.

* Exposure to nonperforming loans is down; no new threats like loans to less-developed countries and leveraged-buyout loans are on the horizon. Also, with interest rates as low as they are, real estate operators are bidding more aggressively for properties the banks are trying to unload.

* Even with regard to apartment house loans, banks see a better position ahead. For with uncertainty over jobs, many people are renting instead of buying-raising occupancy rates sharply.

* Finally, banks are having far less difficulty than in the past in trimming staff or closing branches.

This, Harry adds, is one good legacy of the thrift debacle.

So, he sees bank capital raising, bank earnings coming back, and a much more positive tone to the industry than at any time in recent memory.

Historical Perspective

But why does this necessarily mean that banks must raise their dividends in an environment where capital position means so much to the regulators and the analysts?

Harry Keefe looks at history for an answer.

"If banks want to grow, they need higher multiples. How can a major bank with a price of six times earnings take over a bank with a 10 multiple without tremendous dilution? That major bank must rise its price/earnings ratio.

"But we saw in 1974 that when banks in the Southeast cut their dividends, many bank P/E's plummeted. Whereas in the past banks always sold at higher multiples than industrials, because the investor could count on a steady yield as he would get with a preferred stock, once bank dividends became uncertain, these multiples plummeted.

"The only way banks can get those multiples up above those on industrials again is to raise dividends and restore the image of a bank stock as a yield vehicle. And now they have the capital and the earning potential to do this."

Regulators' Choice

But what about the regulators? Will they let the banks raise their dividends and thus pay out some of the new capital that the industry has?

Harry's answer: "The regulators can't have it both ways. They can't tell the banks that they have to raise capital and at the same time prevent the banks from rewarding these investors when earnings positions and capital strength make such rewards possible.

"If banking it to get capital it needs for future growth, the investors must be included in the loop, and this means higher dividends."

Mr. Nadler is contributing editor of American Banker and professor of finance at the Rutgers University Graduate School of Management.

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