Citigroup Inc. and Bank of America Corp. are among lenders that may have to temper plans to raise dividends and buy back stock next year as the Federal Reserve strengthens capital tests for the biggest U.S. banks.
The Fed imposed the tougher standards on the 31 largest U.S. banks yesterday, releasing the criteria for measuring their wherewithal if the U.S. economy sours and major trading partners default on their debt. Lenders need to prove they have the capital to withstand a “severe” U.S. recession with 13 percent unemployment and an 8 percent decline in gross domestic product before they can increase dividends or repurchase shares.
The more pessimistic scenario will damp banks’ ambitions to return more capital to shareholders, whose holdings have been decimated. The KBW Bank Index of 24 U.S. lenders has plunged 31 percent this year through yesterday and was down 70 percent from its all-time high in February 2007.
“It’s going to be very difficult for any of these companies to do any major buybacks into next year,” said Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia and an analyst at FBR Capital Markets Corp. in Arlington, Virginia. Bank of America and Citigroup’s “chances of upping a dividend or buying back any stock next year are almost zilch.”
The Fed limited banks to returning 60 percent of their retained earnings to shareholders in 2011, split evenly between dividends and share repurchases. Glenn Schorr, an analyst at Nomura Holdings Inc., said some banks may be restricted even further, to about 40 percent, under the more adverse scenario.
‘That’s a Disaster’
“The tighter you stress and the more extreme you stress, the more careful you’ll be in terms of letting banks return capital,” Schorr said in a phone interview.
The Fed’s stressed scenario calls for unemployment to hit 12 percent by next year and 13 percent in 2013. It also tests banks’ performance in an economic decline that begins this quarter and bottoms in the first quarter of next year, with real gross domestic product falling 8 percent and home prices dropping 20 percent during the next two years.
“An 8 percent decline in GDP, that’s a disaster,” Miller said. “That’s not a recession.”
The so-called supervisory stress scenario used earlier this year examined how lenders would fare if U.S. unemployment climbed to 11 percent, real gross domestic product dropped 1.5 percent, house prices fell 6.2 percent and stocks plunged 28 percent by year-end. The jobless rate has remained at about 9 percent all year.
JPMorgan, Goldman Sachs
The test also subjects the trading operations of the six-biggest U.S. banks -- JPMorgan Chase & Co., Bank of America, Citigroup, Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley -- to portfolio “shocks” based on asset price moves in the second half of 2008.
“This is similar to what we saw them do in the original stress tests in 2009,” said Andrew Marquardt, an analyst at New York-based Evercore Partners Inc. “That will be more painful for those banks. In 2009, that was a particular point of contention.”
Bank of America fell 3.7 percent to $5.17 at 2:03 p.m., the biggest drop in the Dow Jones Industrial Average. Citigroup also declined 3.7 percent to $23.55.
Citigroup, the third-biggest U.S. lender, has been touting a 2012 payout since October 2010, when CEO Vikram Pandit said shareholders could gain from a “return” of capital. Pandit, 54, introduced a 1-cent dividend in May after scrapping the payout in February 2009.
Charles Peabody, an analyst at Portales Partners LLC, predicted in an Oct. 18 note that the bank would introduce an annual dividend of up to 76 cents a share next year. Citigroup may opt to buy back shares if the stock remains “depressed,” he wrote. That dividend is still “well within reason” even with the tougher test, Peabody said today in a phone interview. Citigroup had dropped 48 percent this year through yesterday.
“Our plans have not changed,” Jon Diat, a spokesman for New York-based Citigroup, said in an e-mailed statement yesterday. “Subject to regulatory approval, Citi intends to begin returning capital to shareholders next year and believes the pace of return can increase in 2013 and beyond as economic conditions improve.”
A 2012 payout also depends on the firm reducing unwanted assets in its Citi Holdings division while taking advantage of tax benefits, Diat said.
Bank of America CEO Brian T. Moynihan, 52, who already backtracked on plans to raise the dividend earlier this year, may not be able to increase the payout in 2012 either, analysts including Miller and Marquardt said.
‘Darn Well Sure’
“We will ask for a dividend when we’re darn well sure that we’ll get approval, and we’re not going to ask for it a minute before,” Moynihan said during an Aug. 10 conference call with investors. “This is one that I’ve had no success on so far” in predicting, he said. The firm had a 64-cent quarterly payout until 2008. Jerry Dubrowski, a Bank of America spokesman, declined to comment on the Fed announcement.
Healthier U.S. banks including Wells Fargo, JPMorgan, Goldman Sachs and Morgan Stanley may be allowed to buy back some stock and moderately boost dividends next year, Miller said.
“This is further confirmation that we will have a growing divergence among the bank group, between those with good fundamentals able to deploy capital versus those who are not there yet,” Marquardt said, citing Citigroup and Charlotte, North Carolina-based Bank of America as lenders whose plans to return capital may be curtailed.
‘Pull the Reins’
While the Fed probably won’t “pull the reins on the current pace of capital returns among banks, we think the bar has been raised for incremental requests,” Schorr told clients in a research note today. “Any banks that were likely close to receiving approval last year will need to wait a bit longer.”
The test will be “more onerous” for large banks with significant ties to Europe, posing the biggest burden on JPMorgan, Bank of America, Citigroup and Morgan Stanley, according to a research note today by Goldman Sachs analysts led by Richard Ramsden. Lenders including Wells Fargo and American Express Co. will perform well under the new parameters and are the best-positioned among banks to increase dividends or buy back more shares next year, the analysts said.
JPMorgan, led by CEO Jamie Dimon, quintupled its dividend to 25 cents earlier this year and received the go-ahead to repurchase $8 billion of shares in 2011 out of a total $15 billion approved by the Fed.
‘Hard to Tell’
“It’s hard to tell what we’re supposed to do and how we’re supposed to do it,” Dimon, 55, told analysts during an Oct. 13 conference call. “We’ll be figuring it out, having conversations with regulators.” Joe Evangelisti, a JPMorgan spokesman, declined to comment on the new test criteria.
Wells Fargo CEO John Stumpf boosted the quarterly payout at the San Francisco-based bank from 5 cents to 12 cents earlier this year, and the company announced it would repurchase 200 million shares. Chief Financial Officer Timothy J. Sloan told investors Nov. 3 that he was “optimistic” the Fed would let the firm boost the payout and repurchase more shares next year.
“We look forward to the process, we’ve got a great story to tell,” Sloan said. Ancel Martinez, a Wells Fargo spokesman, declined to comment on yesterday’s announcement.
The Federal Reserve expanded its capital test to companies with at least $50 billion in assets, adding 12 banks to its list for 2012. The stress tests, officially called the Comprehensive Capital Analysis and Review, or CCAR, have become a centerpiece of the central bank’s oversight of the largest financial firms.
Lenders must show that their capital -- the buffer between a bank’s assets and liabilities that helps shield depositors from losses -- would remain above 5 percent of assets even if the dire economic scenario materializes. On that basis, most of the largest banks will pass the tests, Edward Najarian, head of bank research at International Strategy & Investment Group Inc., wrote today in a note to clients.
The Fed rejected MetLife Inc.’s request to raise its dividend earlier this year, telling the New York-based insurer it had to wait until its portfolio was tested against a “revised adverse macroeconomic scenario” being developed for the 2012 tests, the company said in an Oct. 25 statement. The biggest U.S. life insurer may speed plans to shed its bank subsidiary, which subjects it to Fed oversight.
“At the end of the day, a stress test is to demonstrate to investors and the marketplace that the banks are strong and can withstand problems in their portfolios,” said Fred Cannon, a bank analyst with KBW Inc. in New York. “It’s all about credibility.”