Fed approves dividend hikes and bank dividend buybacks: what’s next?
AAs expected, the big banks have cleared the 2021 stress tests conducted by the Federal Reserve. Therefore, additional restrictions on dividend hikes and share buybacks that were in place since last year due to uncertainty over the impact of the coronavirus pandemic will cease to be in effect as of. of the end of the month.
The central bank noted that banks “continue to have high levels of capital” and can withstand a “severe recession”. Vice Chairman of Supervision Randal K. Quarles said: “Over the past year the Federal Reserve has carried out three stress tests with several different hypothetical recessions and all have confirmed that the banking system is strongly positioned. to support the ongoing recovery.
Thus, the big banks, including JP Morgan JPM, Citigroup VS, Bank of America BAC, Goldman Sachs GS and Wells fargo WFC will no longer face any restrictions on its capital distributions.
While all COVID-19 Era Restrictions are abolished, banks are still subject to the normal restrictions of the Fed’s stress capital buffer (SCB) framework. The SCB framework, finalized last year, requires banks to maintain sufficient capital to “survive a severe recession”. If a bank fails to maintain this, it will face limitations on capital distributions and discretionary bonus payments.
Detailed analysis of the 2021 stress test result
The hypothetical scenarios for this year’s stress tests included baseline and severely unfavorable levels, and covered 13 quarters through the first quarter of 2024. The most difficult scenario was characterized by a severe global recession, as well as heightened stress. in the commercial real estate (CRE) and corporate debt markets.
The unemployment rate would rise to 10.75% by the third quarter of 2022. In addition, real GDP during the same period would fall by 4%, with stock prices plunging 55%. In addition, severe recessions in the eurozone, the UK and Japan, and a significant slowdown in “developing Asia” were part of this hypothetical scenario.
In this scenario, the 23 participating banks would incur losses of $ 474 billion (in total), including about $ 160 billion in losses from CRE and business loans. Still, the banks’ core capital ratio (CET1) would drop to 10.6%, which is still more than double the minimum requirement of 4.5%.
Of all the banks, the CET1 ratio of HSBC Holdings’ US operations fell to the lowest level, falling to 7.3%, while Deutsche Bank’s US operations recorded the highest CET1 ratio of 23, 2%.
Big rewards await banking investors
In 2020, banks faced real economic shocks in the wake of the coronavirus pandemic, which by many measures were more extreme than the Fed’s hypothetical scenarios. Despite this, the banks managed to pass two series of stress tests (June and December).
Nevertheless, in June 2020, the central bank limited the distribution of the banks’ capital (maintaining dividend distributions and suspending redemptions) so that it does not exceed their recent profits. This was done to preserve liquidity due to economic uncertainty. Thus, few banks like A capital letter COF and Wells Fargo had to cut their quarterly dividends.
Although some of the limitations were removed following the December 2020 stress test by allowing banks to resume buybacks, the restrictions on dividends remained in place. Subsequently, many banks including JPMorgan, Morgan stanley MS, Citigroup and Wells Fargo have resumed buyouts.
Due to restrictions last year, banks like Bank of America and US Bancorp have accumulated huge levels of capital. Now that the banks are free from these limits, they will come up with substantially important plans. Notably, analysts expected banks to reward shareholders with payments worth more than $ 100 billion over the next four quarters.
In addition, so far this year, the KBW Nasdaq Bank Index has gained more than 29%. The sharp rise in bank stocks appears to be in part due to expectations that the big banks will easily pass the 2021 stress test and distribute huge payouts to shareholders.
Banks are expected to rally behind once they start revealing their plans. As the Fed has asked banks not to do this until 4:30 p.m. ET on Monday, June 28, we’ll have to wait a few more days.
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