Nov. 18 (Bloomberg) -- The Federal Reserve issued guidelines on how it will decide whether large U.S. banks may increase dividends and buy back shares, requiring the lenders to submit to stress tests of capital levels.
Lenders must maintain a Tier 1 common equity ratio of 5 percent after any distributions, in addition to showing they can absorb losses if the economy sours and how they will meet Basel III capital rules, the Fed said in documents released yesterday. Companies must repay or replace any government investment with preferred or common stock before raising payouts, it said.
The Fed is asking the 19 banks it stress-tested last year to explain impacts from mortgage repurchases and the Dodd-Frank law after banks including JPMorgan Chase & Co. expressed a desire to raise dividends. Comerica Inc., the Dallas-based bank that posted annual profits throughout the financial crisis, boosted its quarterly dividend to 10 cents a share on Nov. 16.
“The Fed has clearly made a decision that the industry, by and large, is able to or needs to issue dividends, and they want to be ahead of it,” said William Sweet, a former attorney at the Federal Reserve and a partner at Skadden, Arps, Slate, Meagher & Flom in Washington. “They’re saying it’s OK with them, but saying so in a way that makes sure only the banks who are in good shape are allowed.”
Banks including JPMorgan, Wells Fargo & Co., U.S. Bancorp and PNC Financial Services Group Inc. may raise dividends, said Jennifer Thompson, an analyst at New York-based Portales Partners LLC.
“You will see a number of the stronger banks increase their dividends over the next quarter,” Thompson said in a phone interview. She has a “hold” rating on Comerica, the 15th-biggest U.S. commercial lender by assets. “The regulators have put rules in place and now it will be a matter of making individual decisions for each bank.”
Banks that raise dividends will likely pay out 15 percent to 20 percent of earnings, Goldman Sachs Group Inc. analysts led by Richard Ramsden wrote today in a research note. About 60 percent of capital returned to shareholders will come through share repurchases at large banks, according to the note.
Goldman analysts said the first dividend raises will come in the first quarter. Vivek Juneja, an analyst at JPMorgan, said in a note today that U.S. banks may postpone dividend increases until the second quarter of next year.
The Fed is asking large banks to submit capital plans by Jan. 7, 2011, regardless of whether they plan to raise dividends or buy back stock. The Tier 1 common equity ratio is a regulatory gauge of a bank’s capital and its ability to withstand losses.
The capital plans must provide expected losses and capital levels under economic scenarios defined by the bank, as well as under adverse conditions defined by the Fed. They will occur on a regular basis, the regulator said in a statement.
The capital plans will include expected losses from banks’ different lines of business, including charges related to mortgage repurchase requests, according to a person briefed on the program. They will also include any expected impact from the Dodd-Frank financial-overhaul plan, according to the Fed documents. The plans aren’t likely to be made public, the person said.
“There is a requirement under Dodd-Frank to do periodic government and internal stress tests, so this is entirely in line with that,” said Sweet. “I wouldn’t be surprised to see in the long term that stress tests will be somehow tied to dividends -- that they’ll want to see the tests before you declare dividends to make sure there’s nothing awry.”
The Fed guidelines give it flexibility in assessing banks’ ability to raise payouts, and the regulator could take into account “qualitative attributes” of lenders in addition to capital levels, Nomura Holdings Inc. analyst Glenn Schorr said yesterday in a note to investors.
The Fed said it expects to begin responding to capital distribution requests in next year’s first quarter. Banks must currently maintain a Tier 1 common ratio of 2 percent. The Basel Committee on Banking Supervision agreed in September to triple the amount of top-quality capital banks must hold and narrowed the definition of which capital qualifies. The agreement covers 27 member countries.
“Our approach to considering such requests will be a conservative one,” Fed Governor Daniel Tarullo said in a speech in Washington last week. “We also expect that firms will have a sound estimate of any significant risks that may not be captured by the stress testing.” He cited potential demands for refunds from investors who bought faulty mortgages, which could run into billions of dollars for the biggest home lenders.
Bank of America Corp. had a Tier 1 common equity ratio of 8.45 percent as of Sept. 30, according to a regulatory filing. JPMorgan’s ratio was 9.5 percent, while Citigroup Inc. had a 10.3 percent ratio and Wells Fargo’s was 8 percent, according to company filings.
Concerns that bank capital was under pressure from souring loans prompted Fed officials in February 2009 to issue a letter to its regional supervisors telling them banks “should reduce or eliminate dividends” when earnings decline or the economic outlook deteriorates. The new guidelines may show the Fed’s confidence in banks’ health is being restored.
Comerica also authorized the repurchase of as much as 7 percent of stock outstanding, according to a company statement. In March, Comerica repaid $2.25 billion to the Troubled Asset Relief Program and in October it redeemed $500 million of trust-preferred securities, which will be discontinued as a form of regulatory capital starting in 2013.
Wells Fargo Chief Financial Officer Howard Atkins, 59, said last month that a dividend increase is a “top priority” for the bank. JPMorgan Chief Executive Officer Jamie Dimon, 54, said he was “reasonably hopeful” the firm will be able to raise its payment in 2011’s first quarter and that regulators were open to the idea.
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