Strongest U.S. Banks May Boost Shareholder Payouts 53% After Fed Tests

Banks Sweat Dividends in Extended Fed Stress Tests

U.S. banks that pass the Federal Reserve’s annual stress tests are strong enough to boost quarterly payouts to shareholders 53 percent on average, disbursing $109 billion over the next 15 months, according to analysts.

Citigroup Inc., which pays a token 1-cent dividend after failing last year’s test, is seen leading increases with a 60-fold jump in quarterly distributions through dividends and stock buybacks, according to the average of analysts’ estimates compiled by Bloomberg. While rewards from Wells Fargo & Co. and JPMorgan Chase & Co. will rise less than average, the payouts will be the largest of the 25 publicly traded U.S. banks tested.

The big unknown, analysts say, is whether the Fed will fail any banks Wednesday by faulting the quality of their internal planning, rather than their strength. In addition to Citigroup, investors are watching Bank of America Corp., which said last month that regulators demanded changes to some of its models. In an initial test last week, Goldman Sachs Group Inc. came closest to falling below some regulatory minimums as the firm viewed its performance more optimistically than the Fed’s examiners did.

“The results last week were disappointing for some banks,” said Jeff Bahl, who helps manage about $7.7 billion at Bahl & Gaynor Inc., including bank stocks. “There is significant frustration from investors if you’re a bank that’s not returning capital in a significant way because you’re not communicating with your regulator.”

Past Failures

The Fed began stress tests on the nation’s biggest lenders in 2009 after the financial crisis cast doubt on their stability. The first round last week found that all 31 banks examined, including U.S. units of six foreign lenders, have enough capital to withstand nine quarters of stressful economic conditions. The second and more difficult round gauges their ability to weather losses and still pay dividends, buy back stock or make acquisitions. Firms can modify their capital plans in the week before the final results, to be released at 4:30 p.m. Wednesday in Washington.

Those that fail can be blocked from boosting payouts, forcing executives to shore up capital or internal systems while facing shareholders eager for more cash. In addition to New York-based Citigroup, the U.S. units of Royal Bank of Scotland Group Plc, HSBC Holdings Plc and Banco Santander SA failed last year after the Fed’s so-called qualitative look at risk management, corporate governance and internal controls.

“Some banks still don’t have it right,” said Shannon Stemm, an analyst at Edward Jones & Co. “Six years after this process started, we are still in the phase of trying to figure out what the Fed is testing for exactly.”

Zions Bancorp, which was rejected last year because its capital fell below the minimum required, had the lowest Tier 1 common ratio among banks in the round of tests last week.

Goldman’s Buffer

Estimates for banks’ payouts were compiled from seven analysts before last week’s results were announced. Four later revised some projections after the Fed was tougher than anticipated on firms most reliant on investment banking and trading.

While Goldman Sachs’s performance in that round raised concern its cushion of extra capital is too slim to match past payouts, analysts said firms can compensate by delaying share buybacks to later quarters or taking other steps. New York-based Goldman Sachs, for example, could sell preferred stock to maintain its buffer over the minimum ratio, according to analysts at Stifel Financial Corp.’s KBW unit.

Past Fed tests let banks make payouts in the four quarters that followed. This time, the test will determine payouts for five quarters. The analysts’ estimates combine dividends and buybacks for that period. Quarterly averages during that time were compared with those of the past year’s net payouts as calculated by KBW. The six biggest banks are projected to disburse about $70 billion -- if they pass.

Biggest Banks

Wells Fargo will probably pay more than $22 billion over the next 15 months, or about a third more per quarter than in the previous year, analysts estimate. JPMorgan may return more than $17 billion, or an increase of 29 percent per quarter, they predicted. Citigroup could pay more than $9 billion. Bank of America can probably boost rewards past $8 billion, more than tripling its quarterly payout. Goldman Sachs’s payouts are estimated to exceed $8 billion, about 73 percent more per quarter, while Morgan Stanley’s may surge past $4 billion, or almost six times the previous quarterly level.

The U.S. units of Deutsche Bank AG and Madrid-based Santander are among those that will probably fail on qualitative grounds this year, the Wall Street Journal reported Feb. 20, citing unidentified people familiar with the matter. That would limit the U.S. units from paying dividends to their European parents or other shareholders, the newspaper said.

Payout Ratios

“The foreign banks have a special set of challenges and there’s speculation that some of them may not do so well,” David Little, of Moody’s Analytics, said in an interview. “For most of the banks that have been doing stress testing in the U.S., they’ve had a lot of time to get used to the bar being raised.”

Analysts typically focus on the median payout ratio, or the portion of net income meted out in dividends and buybacks. This year that may rise to 79 percent, matching the average from 1999 to 2006, according to Barclays Plc estimates for 23 of the banks.

While the portion used for buybacks has eclipsed pre-crisis levels, dividend ratios remain lower. The Fed has said banks that ask to return more than 30 percent of earnings in the form of dividends will receive “particularly close scrutiny.”

“This is significant that you’re back to some pre-crisis levels,” said Jason Goldberg, a Barclays analyst. “It’s another sign that the banking industry is back on track.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE