Fed Says Some of 19 Largest Banks Can Resume Dividends After Stress Tests

Fed Says Some of 19 Largest Banks Can Resume Dividends After Stress Tests

The Federal Reserve cleared some of the 19 largest U.S. banks to increase dividends, buy back shares or repay government aid after “significant improvement” in their capital and the economy.

The banks, including firms such as Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM), have increased common equity by more than $300 billion from the final quarter of 2008 through the end of 2010, the Fed said in a paper released today in Washington on its most recent review of bank capital.

“Overall, both the quantity and quality of capital at many large bank holding companies have improved since the financial crisis,” the Fed said. “The return of capital to shareholders under appropriate conditions is a step in the process of improvement in the financial sector and will help to promote banks’ long-term access to capital.”

JPMorgan, Wells Fargo & Co. (WFC) and Minneapolis, Minnesota- based U.S. Bancorp all announced plans to increase dividends today.

The KBW Bank Index of 24 companies advanced 1.9 percent at 12:45 p.m. in New York. Wells Fargo climbed 2 percent to $32. New York-based JPMorgan, the second-largest U.S. bank by assets, jumped 2.9 percent to $45.87.

“This is the strongest signal yet that the economy is starting to return to normal,” said Jaret Seiberg, a financial policy analyst for MF Global’s Washington Research Group. “Banks are going to be significantly raising their dividends and engaging in share buybacks in a way that recognizes their return from much more dire financial straits.”

Higher Standards
The Fed’s stress tests are part of a move toward higher standards for capital and risk management mandated by U.S. legislators and international regulatory accords. The Fed wants to ensure bank boards make capital-payout decisions while weighing a full range of risks and their capital needs for at least two years.

San Francisco-based Wells Fargo, the nation’s largest home lender, authorized the repurchase of 200 million shares and a special dividend of 7 cents a share, which will raise the first- quarter payout to 12 cents. JPMorgan said it will boost its quarterly dividend to 25 cents a share from 5 cents and authorized a $15-billion stock repurchase.

Dividend Limit
“In 2011, firms generally are expected to limit dividends to 30 percent or less of anticipated earnings,” the Fed said. At the end of April, the Fed will deliver “detailed assessments” of the plans “including feedback on areas where the plans and processes need to be strengthened.”

The central bank also said that approval of plans would only apply to 2011. Capital distributions in 2012 will be subjected to a future supervisory review.

“In reality, bank holding companies would be expected to reduce distributions under adverse conditions,” the Fed said.

The dividend increases were one of the most carefully screened payouts in U.S. regulatory history, with more than 100 Fed staff working on the analysis. The central bank’s involvement in decisions normally reserved for boards shows how far the Dodd-Frank Act has pushed regulators into corporate governance.

Central bank supervisors asked the banks to test the performance of their loans, securities, and earnings against at least three economic scenarios. Banks devised baseline and adverse scenarios, and Fed supervisors provided a separate adverse scenario involving another recession with unemployment exceeding 11 percent.

Quality, Quantity
“Overall, both the quantity and quality of capital at many large bank holding companies have improved since the financial crisis,” the Fed release said. The 19 companies’ Tier 1 common ratio rose to 9.4 percent in the fourth quarter of 2010 from 5.4 percent two years earlier, the Fed said.

The central bank is taking “a measured and conservative approach in considering such capital distributions,” because of “continued uncertainty around the pace and strength of the economic recovery in the United States and abroad, and the extraordinary nature of the 2007-2009 financial crisis.”

Unlike the stress tests of May 2009, the Fed did not publish the capital buffer needs of specific banks. In this case, the Fed is allowing boards to make the announcements. Fed officials want long-range capital planning to be a regular regimen at the banks.

No Disclosure
“The Federal Reserve does not intend to disclose any firm- specific results,” from the test, the report said.

The tests are being overseen by a new financial-risk unit assembled by Fed Chairman Ben S. Bernanke and Fed Governor Daniel Tarullo. Known as the Large Institution Supervision Coordinating Committee, or LISCC, the unit draws on the Fed’s ranks of economists, quantitative researchers, regulatory experts and forecasters and looks at risks across the financial system. The LISCC last year helped Bernanke respond to an emerging liquidity crisis faced by European banks.

Regulators in this review made one of the largest data requests in Fed history, outside of normal regulatory reporting, asking banks for information about their securities, loans and other holdings. This gave the Fed the ability to check and even challenge the assumptions banks make about their portfolios.

The Fed said its adverse economic scenario included a 1.5 percent decline in gross domestic product from the fourth quarter of last year through the end of 2011. The scenario assumed growth resumes, with output rising 3.4 percent in 2013. Unemployment would peak at 11.1 percent in the first quarter of 2012 and drop back to 9.6 percent by the end of 2013.

Home Prices
Home prices would fall 6.2 percent in 2011 and 4.1 percent in 2012. The scenario also included a 27.8 percent drop in equity prices where The Dow Jones Total Stock Market Index would fall to 8,716 in the fourth quarter of 2011.

“The six largest firms were required to estimate potential losses stemming from trading activities and private equity investments using the same severe global market shock scenario” that was applied in the May 2009 stress tests, the Fed said.

Banks were asked to study capital performance over at least nine quarters through the end of 2012.

A “key benchmark” was whether a bank’s adjusted Tier 1 common ratio “exceeded a supervisory reference level of 5 percent on a pro forma, post-stress basis” in each quarter, the Fed said. The Tier 1 common ratio is the ratio of Tier 1 common capital - defined as common equity minus Tier 1 deductions - to risk-weighted assets.

source: bloomberg.com