A steady decline in dividend yields is rarely seen as a positive by bankers and investors, though the latest dive is an exception.

Dividend yields are a function of a company's annual dividend divided by its stock price. During the financial crisis, yields fell as banks slashed dividends to shore up capital. Today, they are falling as bank stocks recover faster than dividend payouts.

Most investors seem content to take stock price appreciation over higher dividends, taking the sting out of the lower dividend yields.

"While people love to use the phrase 'cash is king,' many times it is the intangible feeling of confidence that is maybe just as important as cash," says Joe Stieven, the chief executive at Stieven Capital Advisors. "Cash is nice, but the confidence that is portrayed to the market can be just as important."

Bank stocks have performed relatively well this year. The KBW Bank Stock Index was up 13% through Thursday. The index had actually appreciated by 22% through May 1, but economic worries and concerns following JPMorgan Chase's (JPM) trading miscue have hurt bank stocks in recent weeks.

"Banks are coming back to life, albeit slowly, but they are coming back to life," says Paul Schaus, president of bank consulting firm, CCG Catalyst.

Rising stock prices have pushed the average dividend yield for banks with $20 billion in assets down to 1.6% at March 31, compared to 1.8% six months earlier, according to data from Sandler O'Neill & Partners. To put it into perspective, the yield spiked to 1.8% last year because of a severe stock market decline that made the flat cash dividends look better on paper. So now is the optimal time for bank investors to feel more confident in the lower yields, bankers say.

"This [yield trend] all stems from the fact that investors have a sense that most of the credit problems have been addressed and are behind us," says Gerard Host, the president and chief executive of Trustmark (TRMK) in Jackson Miss.

Host, who had just returned from the annual Gulf South Bank Conference on Wednesday, says dividend yields have become a key selling point for the company, which boasts a 3.7% yield.

Yields are nowhere near where they were before the financial crisis, but most industry observers say they would prefer to see lower yields right now, rather than have banks in a rush to boost dividends.

"You can't sustain a 7% yield," says Dan Bass, a managing partner at FBR Capital Markets. Bass also expressed concern after hearing an unnamed banker tout a yield above 4% at a recent investors' conference. "At some point if it's too high, then you have to cut back on dividends," he says. "You need growth capital."

It's a difficult balance, bankers say. The key is to show some cash dividend and earnings stability, regardless of yield fluctuations.

"There are so many variables," cautions Gregory Mitchell, the president and chief executive of First PacTrust Bancorp (BANC) in Irvine, Calif. He says some banks have dividend payout rates as high as 40% of their income. While other banks are preserving cash to repurchase common stock or grow the bank further, ideally boosting dividend payouts at a later date.

Each bank's strategy may depend on the breakdown of retail and institutional investors. Host says most community banks have more retail investors, who tend to prefer the steady cash flow that comes from a quarterly cash dividend.

"From the perspective of a retail investor, they like that dividend," Host says. (Trustmark has a large concentration of institutional investors but has seen a recent spike in retail investors.) "They like the certainty of it and they like the consistency of it."

"Different investors have different objectives," Mitchell adds. "I think shareholders just want to see a stable dividend."

Cash dividends remain down, but Host says other fixed assets like certificates of deposit are so much lower that even an average dividend yield of 1.6% pays better than most CDs.

Despite some industry wide improvements to bank financials, smaller banks are actually paying less in cash dividends than they were a year ago, according to data compiled by Sandler O'Neill.

Investors who hypothetically owned one share of each of the 430 publicly traded banks with $20 billion or less in assets would have received $419 in dividend income in the first quarter. That represents a 2% decline from the fourth quarter and a flat result from a year earlier, according to Sandler O'Neill. As earnings improve, investors may start pressing banks to restore or increase payouts, as long as regulators will allow it. Still, there are examples of boards opting to cut dividends or even eliminate them.

"Investors are expecting more and more banks to be resuming dividends of some type," Stieven says. "In general, the industry is by far much healthier than year ago. At this point, if an investor wants a dividend and the bank is not paying, there could be a bit of stand-off."

"The pressure is still out there in terms of the loss on the revenue side and pressure from investors to get a higher return on equity," Schaus says. He says JPMorgan Chase's snafu could stymie bank stock prices for the foreseeable future.

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