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As expected, major banks have cleared 2021 stress tests conducted by the Federal Reserve. Hence, additional restrictions on dividend hikes and share repurchases that were in place since last year due to the uncertainty over the impact of coronavirus pandemic will cease to be effective from this month end.
The central bank noted that banks “continue to have strong capital levels” and can withstand “severe recession.” The vice chair for Supervision Randal K. Quarles, said, “Over the past year, the Federal Reserve has run three stress tests with several different hypothetical recessions and all have confirmed that the banking system is strongly positioned to support the ongoing recovery.”
While all the COVID-19 era restrictions are being removed, 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.” In case a bank fails to maintain this, it will face limitations on capital distributions and discretionary bonus payments.
Detailed Analysis of 2021 Stress Test Outcome
This year’s hypothetical scenarios for stress test included Baseline and Severely Adverse, and covered 13 quarters through the first quarter of 2024. The toughest scenario was characterized by severe global recession, along with heightened stress in commercial real estate (CRE) and corporate debt markets.
The unemployment rate would increase to 10.75% by the third quarter of 2022. Further, real GDP in that same time frame would fall 4%, with equity prices plunging 55%. Additionally, severe recessions in the eurozone, the U.K., and Japan, and a significant slowdown of in “developing Asia” were part of this hypothetical scenario.
Under this scenario, all 23 participating banks would incur $474 billion losses (in aggregate), with roughly $160 billion losses from CRE and corporate loans. Yet, banks’ common equity tier 1 (CET1) ratio would decline to 10.6%, which is still more than twice the minimum requirement of 4.5%.
Of all banks, HSBC Holdings’ American operations’ CET1 ratio fell to the lowest level, dipping to 7.3%, while Deutsche Bank's U.S. operations recorded the highest CET1 ratio of 23.2%.
Big Rewards Awaiting Bank Investors
In 2020, banks faced real-life economic shocks following the coronavirus pandemic, which by many measures were more extreme than the Fed’s hypothetical scenarios. Despite this, banks were able to clear two rounds of stress tests (June and December).
Nevertheless, in June 2020, the central bank put limits on banks’ capital distribution (maintaining dividend payouts and suspending repurchases) so that it did not exceed their recent profits. This was done to preserve liquidity owing to the economic uncertainty. So, few banks like Capital One (COF - Free Report) and Wells Fargo had to cut quarterly dividends.
Though some of the limitations were removed following December 2020 stress test by allowing banks to resume buybacks, restrictions on dividends remained in place. Subsequently, many banks including JPMorgan, Morgan Stanley (MS - Free Report) , Citigroup and Wells Fargo resumed repurchases.
Because of the restrictions last year, banks like Bank of America and U.S. Bancorp have piled up huge levels of capital. Now that banks are free from these limits, they will come up with substantially large plans. Notably, analysts have been expecting banks to reward shareholders with payouts worth more than $100 billion in combine over the next four quarters.
Further, so far this year, the KBW Nasdaq Bank Index has rallied more than 29%. The sharp rise in bank stocks seems to be partly driven by expectations that major banks will easily pass the 2021 stress test and dole out huge payouts to shareholders.
Banks are likely to rally once they start revealing their plans. As the Fed has asked banks not to do so before 4:30 p.m. ET on Monday, Jun 28, we will have to wait a few more days.
Infrastructure Stock Boom to Sweep America
A massive push to rebuild the crumbling U.S. infrastructure will soon be underway. It’s bipartisan, urgent, and inevitable. Trillions will be spent. Fortunes will be made.
The only question is “Will you get into the right stocks early when their growth potential is greatest?”
Zacks has released a Special Report to help you do just that, and today it’s free. Discover 7 special companies that look to gain the most from construction and repair to roads, bridges, and buildings, plus cargo hauling and energy transformation on an almost unimaginable scale.
Image: Bigstock
Fed Gives Nod to Banks' Dividend Hikes & Buybacks: What's Next?
As expected, major banks have cleared 2021 stress tests conducted by the Federal Reserve. Hence, additional restrictions on dividend hikes and share repurchases that were in place since last year due to the uncertainty over the impact of coronavirus pandemic will cease to be effective from this month end.
The central bank noted that banks “continue to have strong capital levels” and can withstand “severe recession.” The vice chair for Supervision Randal K. Quarles, said, “Over the past year, the Federal Reserve has run 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, major banks including JPMorgan (JPM - Free Report) , Citigroup (C - Free Report) , Bank of America (BAC - Free Report) , Goldman Sachs (GS - Free Report) and Wells Fargo (WFC - Free Report) will no longer face any restrictions on their capital distributions.
While all the COVID-19 era restrictions are being removed, 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.” In case a bank fails to maintain this, it will face limitations on capital distributions and discretionary bonus payments.
Detailed Analysis of 2021 Stress Test Outcome
This year’s hypothetical scenarios for stress test included Baseline and Severely Adverse, and covered 13 quarters through the first quarter of 2024. The toughest scenario was characterized by severe global recession, along with heightened stress in commercial real estate (CRE) and corporate debt markets.
The unemployment rate would increase to 10.75% by the third quarter of 2022. Further, real GDP in that same time frame would fall 4%, with equity prices plunging 55%. Additionally, severe recessions in the eurozone, the U.K., and Japan, and a significant slowdown of in “developing Asia” were part of this hypothetical scenario.
Under this scenario, all 23 participating banks would incur $474 billion losses (in aggregate), with roughly $160 billion losses from CRE and corporate loans. Yet, banks’ common equity tier 1 (CET1) ratio would decline to 10.6%, which is still more than twice the minimum requirement of 4.5%.
Of all banks, HSBC Holdings’ American operations’ CET1 ratio fell to the lowest level, dipping to 7.3%, while Deutsche Bank's U.S. operations recorded the highest CET1 ratio of 23.2%.
Big Rewards Awaiting Bank Investors
In 2020, banks faced real-life economic shocks following the coronavirus pandemic, which by many measures were more extreme than the Fed’s hypothetical scenarios. Despite this, banks were able to clear two rounds of stress tests (June and December).
Nevertheless, in June 2020, the central bank put limits on banks’ capital distribution (maintaining dividend payouts and suspending repurchases) so that it did not exceed their recent profits. This was done to preserve liquidity owing to the economic uncertainty. So, few banks like Capital One (COF - Free Report) and Wells Fargo had to cut quarterly dividends.
Though some of the limitations were removed following December 2020 stress test by allowing banks to resume buybacks, restrictions on dividends remained in place. Subsequently, many banks including JPMorgan, Morgan Stanley (MS - Free Report) , Citigroup and Wells Fargo resumed repurchases.
Because of the restrictions last year, banks like Bank of America and U.S. Bancorp have piled up huge levels of capital. Now that banks are free from these limits, they will come up with substantially large plans. Notably, analysts have been expecting banks to reward shareholders with payouts worth more than $100 billion in combine over the next four quarters.
Further, so far this year, the KBW Nasdaq Bank Index has rallied more than 29%. The sharp rise in bank stocks seems to be partly driven by expectations that major banks will easily pass the 2021 stress test and dole out huge payouts to shareholders.
Banks are likely to rally once they start revealing their plans. As the Fed has asked banks not to do so before 4:30 p.m. ET on Monday, Jun 28, we will have to wait a few more days.
Infrastructure Stock Boom to Sweep America
A massive push to rebuild the crumbling U.S. infrastructure will soon be underway. It’s bipartisan, urgent, and inevitable. Trillions will be spent. Fortunes will be made.
The only question is “Will you get into the right stocks early when their growth potential is greatest?”
Zacks has released a Special Report to help you do just that, and today it’s free. Discover 7 special companies that look to gain the most from construction and repair to roads, bridges, and buildings, plus cargo hauling and energy transformation on an almost unimaginable scale.
Download FREE: How to Profit from Trillions on Spending for Infrastructure >>