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On Tuesday, with the release of Federal Reserve’s stress test results under Comprehensive Capital Analysis and Review (CCAR), many big banks that passed took immediate action to raise their dividends. The Fed allowed these banks to carry on with their capital plans as well.
These banks now have the privilege to increase dividends and buy back shares. Following concerns that banks might not have sufficient capital to counter another financial crisis, they were asked to submit their respective capital plans to the Fed. It was intimated to these banks that payment of higher dividends will be restricted if they fail to meet the requirement of 5% ratio of core capital to risk-weighted assets among other requirements.
The results also brought good tidings for the weaker banks. These banks were given the consent to raise capital by issuing shares to repay Troubled Asset Relief Program (TARP) dues.
Root of the Stress Test
Currently authorized under the Dodd-Frank financial-services law, the stress tests were first introduced after the 2008 financial crisis. During this economic downturn, big financial institutions, like Lehman Brothers and AIG (AIG - Analyst Report), collapsed and several other big banks were at the verge of fading. Therefore, such situation compelled the US government to infuse billions of dollars into credit markets and to save the entire financial system from failing.
The prior tests were conducted during early 2011, late 2010 and 2009. The periodic stress tests monitor the 19 banks that are regulated by the Federal Reserve.
The environment of the last two rounds of stress tests along with the latest one is quite dissimilar to the Fed's first round. The first round, conducted when the country was teetering under tremendous recessionary pressure, was aimed at estimating how much the banks would lose if the economic downturn proved deeper than expected. Since then, the test rounds are more like precautionary measures amid economic recovery.
The Federal Reserve’s latest stress test scenario projections include input data supplied by the 19 banks participating in CCAR 2012 and models created by the regulatory staff and evaluated by a group of Fed economists and analysts.
These models were developed with the intent to inculcate the impact of the macroeconomic and financial market factors that are included in the Supervisory Stress Scenario and distinctive factors of the banks’ loans and securities portfolios, trading as well as other factors affecting losses, revenue and expenses.
Moreover, the Fed's stress test was conducted to find out whether the banks have enough capital to survive another financial crisis, including a hypothetically 13% unemployment rate, 50% fall in stock prices, 21% drop in housing prices along with economic downturn in Europe and Asia. However, the fourth round of stress test had tougher requirements compared with the prior ones.
Further, under the Fed’s 2012 Capital Plan Review, 11 bank holding companies with total assets of more than $50 billion that were not included in the CCAR were also assessed, though not as extensively compared with the CCAR submissions. Moreover, Fed did not disclose their results publicly as the Board did not conduct an independent supervisory stress test for such banks.
Wells Fargo & Company (WFC - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report) and U.S. Bancorp (USB - Analyst Report) are among the major banks that have received clearance from the Fed to raise their dividends or repurchase shares.
Wells Fargo increased its quarterly dividend to 22 cents per share from 12 cents. However, this is much lower than the company’s pre-recession quarterly dividend payment of 34 cents.
JPMorgan increased its quarterly dividend to 30 cents per share from 25 cents. Also, the company authorized a buyback of $15 billion worth of shares, out of which $12 billion is permitted for 2012 and an additional $3 billion is approved till the end of first quarter of 2013.
U.S. Bancorp increased its dividend to 19.5 cents per share from 12.5 cents. The bank also authorized a 100 million share repurchase, which it intends to complete by the end of March 2013.
Another major bank, Bank of America Corporation (BAC), which pays a quarterly dividend of only a penny, passed the test, though has huge holdings of home loans, which might lead to further losses. However, BofA’s capital plan did not include the approval for hiking dividend as the firm’s request was repudiated last year for the same.
Moreover, The Goldman Sachs Group Inc. (GS - Analyst Report) received the Fed’s approval for its capital plan, which includes repurchase of common stock and a dividend increase through the first quarter of 2013.
Banks on Shaky Ground
Citigroup Inc. (C - Analyst Report) withcore capital ratio to risk-weighted assets of 4.9% failed the test. Fed has discarded Citi’s plan to boost capital return, and therefore the bank plans to resubmit its capital plans later this year. However, no objection was pertained for the payment of dividend at current levels. The Fed plans to counter a refurbished capital plan within 75 days.
Apart from Citi, Ally Financial and SunTrust Banks Inc. (STI - Analyst Report) with 2.5% and 4.8% capital ratios, respectively, remain on unstable position, struggling with troubled mortgages and other distressed businesses.
Moreover, the insurance company MetLife Inc. (MET - Analyst Report) also failed the stress test in spite of meeting the 5% capital ratio requirement. The reason for this failure was the amount of risk-weighted capital.
TARP Repayment Still Due
Of the total $245 billion handed out to banks, more than $15 billion is still due.
Many of the regional banks that have still not repaid the entire bailout money will not be allowed to increase their dividend payments, even if they wish to do so. As soon as these banks repay the bailout money they will be allowed to increase dividend payments, provided they meet the requirements to pass the stress test.
Among 31 banks under stress test, Regions Financial Corp. (RF - Analyst Report) and Zions are still to repay the TARP money. However, following the stress test results, these two banks have announced their plans to clear off TARP dues.
The Mode of Recovery
This is not the final round. The big banks will have to undergo the Fed’s stress test once every year. The primary intention of the stress test is to check a bank’s financial strength to fight another financial catastrophe.
The economic benefits of the stress tests are indisputable. These would help to build up weak capital levels of banks, which are always a threat to the economy. Also, this could ultimately translate to less involvement of the taxpayers’ money for bailing out troubled financial institutions.
However, the government must necessarily set some policies so that every industry participants contribute to the overall profitability. While the bigger banks benefited greatly from the various programs launched by the government, many smaller banks are still trying hard to catch up.
No matter what, the approval from Federal Reserve to increase dividend payment will definitely accelerate the pace of economic recovery.
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