The Federal Reserve capped dividends and banned share buybacks by big US banks as it released an analysis showing Covid-19 could trigger $700bn of loan losses and push some lenders close to their capital minimums.
Announcing the results of a trio of exercises on the health of America’s top banks, the Fed on Thursday said 33 lenders that underwent "stress tests" would be barred from buying back their shares until at least the fourth quarter of this year.
The eight biggest had already voluntarily suspended buybacks, which account for about 70 per cent of US bank shareholder distributions, until July. Jamie Dimon, JPMorgan Chase’s chief executive, has said buybacks were unlikely to resume until the outlook for the economy was clearer. The Fed said the "provisions may be extended . . . quarter-by-quarter."
The US central bank stopped short of banning dividends — as European regulators have done during the crisis. Instead, the Fed said third-quarter dividends from the group of banks, which includes domestic giants such as JPMorgan and digital banks like Ally, could be no higher than last year’s and no higher than the average of a bank’s earnings for the four quarters ended June 30.
It deferred decisions on future dividends until the fallout from the pandemic became clearer, spelling further uncertainty for bank investors.
Randal Quarles, Fed vice-chair, said for the first time in a decade supervisors were asking all banks to "reassess their capital needs and resubmit their capital plans to the Federal Reserve later this year". No date was specified.
The Fed’s decision on those plans will depend on "additional stress analyses later in the year". Mr Quarles added: "If the circumstances warrant, we will not hesitate to take additional policy actions to support the US economy and banking system."
Chris Marinac, director of research at investment firm Janney Montgomery Scott, said the Fed actions were "not as bad as it seems on the surface". He added: “I certainly did not anticipate any dividend increases and frankly I still feel 80 per cent plus of the banks maintain their dividends."
Bank shares had rallied on Thursday before the Fed announcement, with Wells Fargo up 4.8 per cent and Goldman Sachs rising 4.6 per cent. In after-hours trading, Wells fell 3.4 per cent and Goldman dropped 3.8 per cent.
Wells’ dividend — $0.51 per share for the last year — is seen as particularly at risk. It compares with average earnings per share of just under $0.52 for the last three quarters, including $0.01 per share in the quarter to the end of March as coronavirus prompted big loan-loss provisions. Earnings in the current quarter are expected to be battered by more loan losses.
The Fed used its analysis to set new minimum capital targets for the banks, which it has asked the lenders not to publish until Monday. Gerard Cassidy, analyst at RBC, said his calculations suggested Goldman was the only bank below its new minimum, though the gap was "very small" at 10 basis points and would be easy to fix before the requirements come into force on October 1. Goldman declined to comment.
Lael Brainard, who has repeatedly broken with peers to vote against measures easing financial regulation, was the only one of five Fed governors to vote against the payout decision. She said it was a "mistake" to allow any distributions that "weaken banks’ strong capital buffers . . . in the first serious test since the global financial crisis".
The Fed’s analysis on the potential impact of the pandemic showed that, in the most extreme scenario, 34 banks would face $700bn of loan losses, versus the $560bn of loan losses under the traditional stress tests, which was based on a scenario set in February.
Under the pandemic scenario, their aggregate capital ratios would fall from 12 per cent at the end of 2019 to 7.7 per cent, assuming they paid zero dividends in 2020. Actual dividend payments for the first two quarters would have wiped another 50 basis points, or 0.5 percentage points, from their capital ratios.
The Fed warned that under the most severe scenario — a double-dip recession with gross domestic product falling 12.4 per cent and unemployment peaking at 16 per cent — the weakest quartile of banks would post aggregate capital ratios of 4.8 per cent, a whisker above the 4.5 per cent regulatory minimum.
In the second-worst scenario — a prolonged recession with 13.8 per cent drop in GDP and unemployment peaking at 15.6 per cent — the weakest quartile would have aggregate capital ratios of 5.5 per cent.
The Fed stressed that the scenarios were not forecasts and the analysis did not take account of "the effects of unprecedented government support", improvements in market conditions since April, subsequent shrinkage in banks’ balance sheets and better than expected unemployment rates.
"The banking system remains well-capitalised under even the harshest of these downside scenarios — which are very harsh indeed," Mr Quarles said.
The Financial Services Forum, which represents the eight biggest US banks, said the results of the exercises "underscore the strength, safety and resiliency of the nation’s largest banks".
For the first time in at least eight years, the Fed made no objections to the capital planning processes at any of the banks, a relief for Credit Suisse which was the only bank censured last year, and Deutsche Bank, which was still considered to be in a "troubled condition" by regulators at the New York Fed in late March.
(Published by Reuters, June 26, 2020)