The Fed capped dividends and banned takeovers by major US banks

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The Federal Reserve capped dividends and banned share buybacks by major US banks as it published analysis showing that Covid-19 could trigger $ 700 billion in loan losses and push some lenders to near their minimum capital.

Announcing the results of a trio of exercises on the health of the largest US banks, the Fed said Thursday that 33 lenders under “stress tests” could not buy their shares until at least the fourth quarter of this year.

The eight largest had already voluntarily suspended buyouts, which account for about 70% of distributions to shareholders of US banks, until July. Jamie Dimon, CEO of JPMorgan Chase, said the takeovers are unlikely to resume until the economic outlook is clearer. The Fed said that “the provisions could be extended. . . quarter by quarter. ”

The US central bank has not banned dividends – as European regulators did during the crisis. Instead, the Fed said the bank group’s third-quarter dividends, which include national giants like JPMorgan and digital banks like Ally, could not be higher than last year and no more higher than the average bank profit for the four quarters ended June 30.

He postponed decisions on future dividends until the fallout from the pandemic became clearer, creating additional uncertainty for bank investors.

Randal Quarles, Vice President of the Fed, said for the first time in a decade that supervisors were asking all banks to “reassess their capital requirements and resubmit their capital plans to the Federal Reserve more late this year. ” No date has been specified.

The Fed’s decision on these plans will depend on “additional stress tests later this year.” Quarles added, “If circumstances warrant, we will not hesitate to take additional political action to support the US economy and banking system.”

Chris Marinac, director of research for investment firm Janney Montgomery Scott, said the Fed’s actions were “not as bad as it looks on the surface.” He added: “I was certainly not expecting a dividend increase and, frankly, I think 80% of the banks and more are maintaining their dividends. ”

Bank stocks rallied Thursday before the Fed’s announcement, Wells Fargo up 4.8% and Goldman Sachs up 4.6%. In after-hours trade, Wells fell 3.4% and Goldman 3.8%.

Wells’ dividend – $ 0.51 per share for the past year – is considered particularly at risk. It compares to average earnings per share of just under $ 0.52 for the last three quarters, including $ 0.01 per share for the quarter at the end of March, as the coronavirus caused large provisions for loan losses. Profits for the current quarter are expected to be beaten by further loan losses.

The Fed used its analysis to set new minimum capital targets for banks, which it asked lenders not to release until Monday. Gerard Cassidy, analyst at RBC, said his calculations suggested that Goldman was the only bank below its new minimum, although the spread is “very small” at 10 basis points and would be easy to correct before entry requirements in effect October 1. Goldman declined to comment.

Lael Brainard, who repeatedly broke up with his peers to vote against easing financial regulations, was the only one of five Fed governors to vote against the payment decision. She said it was a “mistake” to allow any distribution that “would weaken the banks’ solid capital reserves. . . in the first serious test since the global financial crisis. “

The Fed’s analysis of the potential impact of the pandemic showed that, in the most extreme scenario, 34 banks would face $ 700 billion in loan losses, compared to $ 560 billion in loan losses according to tests. traditional resistance, which were based on a scenario defined in February.

In the pandemic scenario, their overall capital ratios would drop from 12% at the end of 2019 to 7.7%, assuming that they paid no dividends in 2020. The actual dividend payments for the first two quarters would have wiped out an additional 50 basis points, or 0.5 percentage points, from their capital ratios.

The Fed has warned that in the most severe scenario – a double-dip recession with a drop in gross domestic product of 12.4% and unemployment hitting a peak of 16% – the weakest quartile of banks would show ratios of total equity of 4.8%, a figure higher than the 4.5% regulatory minimum.

In the second worst-case scenario – a prolonged recession with a 13.8% drop in GDP and unemployment peaking at 15.6% – the weakest quartile would have overall capital ratios of 5.5%.

The Fed stressed that the scenarios were not forecasts and that the analysis did not take into account the “effects of unprecedented government support”, improvements in market conditions since April, shrinking bank balance sheets and better than expected unemployment rate.

“The banking system remains well capitalized, even in the worst of bearish scenarios – which are indeed very harsh,” said Quarles.

The Financial Services Forum, which represents the eight largest US banks, said the results of the exercises “underscore the strength, security and resilience of the country’s largest banks.”

For the first time in at least eight years, the Fed has made no objections to the capital planning process at any of the banks, a relief for Credit Suisse, which was the only bank censored last year, and Deutsche Bank, which was still considered to be in a “troubled state” by New York Fed regulators in late March.

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