Stress Tests to Put a Damper on Dividend Increases

Strategic Insights -

The third round of stress tests conducted by the Federal Reserve will feature a set of stringent economic assumptions that will likely put a damper on dividend increases for even the strongest of the big U.S. banks. The tests, which begin early next year, will evaluate the capital plans of 19 large U.S. banks, including the "big four" of JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, as well as 12 other companies. Analysts predict that the metrics for the tests this time around will be a lot more stringent, with gross domestic product declining 4% vs. 1.5%, unemployment reaching 13%, vs. 11%, home prices falling 21% vs. 11%, and equity markets declining 52% vs. 27%.

Key Takeaways:

  • The third round of stress tests will subject 19 large U.S. banks to a set of stringent economic assumptions, including a 4% decline in gross domestic product, 13% unemployment, and a 21% decline in home prices.
  • Analysts predict that the metrics for the tests this time around will be more stringent than the second round of stress tests earlier this year, which would likely put a damper on dividend increases for even the strongest banks.
  • Bank of America, which had its capital plan rejected by the Federal Reserve earlier this year, is expected to again "screen poorly" in the upcoming stress tests, according to KBW analyst Frederick Cannon.
  • JPMorgan Chase is expected to increase its Basel 1 Tier 1 common equity ratio to 11.4% by the end of 2012, with the company's Basel III ratio increasing to 9.2%.
  • Citigroup is expected to increase its dividend to $0.30 per quarter from $0.01, with KBW forecasts suggesting an 11.7% tier 1 common ratio under Basel I.
  • Wells Fargo is expected to double its quarterly dividend to $0.24 per share in 2012, with KBW projecting $2 billion in share buybacks during 2012.
  • 12 new banks, including Huntington Bancshares, Discover Financial Services, and Northern Trust, will be subject to the stress tests for the first time.

Statistics:

  • Gross domestic product decline: 4% (vs. 1.5%)
  • Unemployment rate: 13% (vs. 11%)
  • Home prices decline: 21% (vs. 11%)
  • Equity markets decline: 52% (vs. 27%)
  • Bank of America's TARP debt: $3.5 billion
  • Wells Fargo's dividend payout ratio: 35% (vs. 30%)
  • Wells Fargo's share buybacks: $2 billion (2012)
  • JPMorgan Chase's Basel 1 Tier 1 common equity ratio: 11.4% (2012)
  • Citigroup's tier 1 common ratio: 6.2% (under Basel III)
  • Wells Fargo's quarterly dividend: $0.24 (2012)

Sources:

  • FIG Partners analyst John Rodis
  • KBW analyst Frederick Cannon
  • JPMorgan Chase (:JPM)
  • Bank of America (:BAC)
  • Citigroup (:C)
  • Wells Fargo (:WFC)
  • Huntington Bancshares (:HBAN)
  • Discover Financial Services (:DFS)
  • Northern Trust (:NTRS)