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Did the Fed perceive shareholders' payouts accurately?

WASHINGTON – The Federal Reserve cap on shareholder payouts from major banks immediately triggered a second guessing game in the banking industry, in which many pass judgment until the path of economic recovery from the pandemic is more secure.

In the publication of its annual stress test results, the Fed said it would require large banks to suspend share buybacks in the third quarter and limit dividend payments to the level that banks paid out in the second quarter. Depending on the results of the individual banks, these distributions could be further limited, the Fed said.

The central bank is also demanding that the 34 banks with more than $ 100 billion in assets that they tested will resubmit their capital plans later this year.

As part of its normal stress test cycle, the Fed also tested banks as a complement to its typical stress test regime against hypothetical economic recovery models from the pandemic to take into account the impact of COVID-19 on bank capital.

While the results of these "sensitivity analyzes" showed that banks would meet the regulatory minimum capital requirements under different economic stress levels, several banks are said to have reached the minimum capital requirement for core capital of 4.5% in the most difficult scenarios. This revelation raised questions about whether the Fed should do more to ensure that banks hold on to capital.

"The board has now taken a medium position with modest restrictions while being cautious about the future," said William Lang, general manager of Promontory Financial Group. "This contradicts the lessons from the last crisis that it was preferable to save capital while the banks were in a stronger position."

Michael Barr, a former deputy secretary for financial institutions in the Treasury Department under the Obama administration under the Dodd-Frank law, said the central bank should have ruled out total dividends, as the stock buyback agency did.

He added that the analysis to justify continued dividends is too backward and does not take into account the possibility that the economy has not even reached the recovery phase as some areas are struggling with an increase in new COVID 19 cases.

"We are in the midst of an unprecedented global pandemic and economic collapse," said Barr. "It doesn't make sense to me. Now is the time for banks to raise additional capital to ensure that they are more resilient. At least the Fed shouldn't allow dividend payments."

This assessment was confirmed by Fed Governor Lael Brainard, who voted against banks' permission to continue paying dividends to shareholders, and said in a statement that it "did not support giving large banks the green light for capital deprivation" .

However, others viewed the Fed's measures as reasonable and believed that the regulator has gone far to ensure that banks can withstand any downturn.

"It is difficult not to see what the Fed has done and to consider it prudent," said Darren King, CFO of M&T Bank in Buffalo, New York, one of the banks that was tested against the Fed scenarios .

King would not say whether the Fed's actions will change anything in the 124.6 billion dollar bank's own plans for buybacks or dividend payments, but he said the decision to limit dividends was either prudent or "with luck." won the pain of the pandemic It will not be so severe and the balance sheets will be strong and ultimately we will have excess capital that we can distribute to shareholders at a later date. "

Banks can disclose their stress capital buffer requirements and planned capital distributions on Monday after the market closes, if they so choose. With banks going through another round of stress tests later this year, some are still considering whether to release this information.

King said M&T Bank is undecided whether to report stress test information on Monday.

"We have our stress capital buffer count, but we'll basically go through a different process in 90 days, and in the meantime, we know we can't buy back shares or change dividends other than reduce them," he said. "So I'm not sure what else to say, so I'm not sure if we're going to say anything."

Wells Fargo, Citigroup, US-Bancorp, Fifth Third Bancorp and Citizens Financial Group declined to comment on the Fed's decisions. In March, as economic uncertainty increased, all five belonged to the group of banks that had temporarily suspended share buybacks until at least the end of the second quarter.

Because the Fed did not disclose how individual companies performed in the sensitivity analysis and instead published the overall results, many were only able to guess which banks outperformed others.

This could play a role in banking decisions about whether to release the stress capital buffer requirement next week.

This buffer, which was completed in March, calculates a bank's stress capital buffer as the difference between a bank's starting and forecast capital ratios under the “highly adverse” stress test scenario, and takes into account the dividends of a bank's common stock as a percentage of risk-weighted assets.

"I assume that most banks will have the need to disclose the stress capital buffer themselves," said Lang. “Withholding disclosure could lead market participants to conclude that there is a problem even though banks are making a strong capital decision. This could be worse than a bank reporting stress capital buffers that are larger than its competitors. "

The Fed's decision not to disclose how individual banks performed under their hypothetical coronavirus scenarios was criticized by many who felt that the sensitivity analyzes were not transparent enough. Barr called this decision a "mistake".

"It didn't make sense to hide details of each company," said Barr, who is now Dean of the Ford School of Public Policy at the University of Michigan. "The stress tests were much less useful than they should have helped us understand the health of the financial system."

In a speech last week, the Fed's Vice President for Supervision Randal Quarles said that the Fed decided to only publish the overall results of the banks tested, also because the agency had not informed companies in advance of the scenarios against which they would test the companies.

"I don't think the Fed wanted to use this sensitivity analysis publicly to target a company," said Adam Gilbert, a partner at PwC. "I also think they don't necessarily want to pick out someone who has to do with pandemic sensitivity, because that can become a self-fulfilling prophecy, so you want to be careful."

In the meantime, some industry observers hoped the Fed would clarify capital plans and the pace of future dividend payments. Instead, the central bank will monitor the capital plans quarterly, even if new capital plans are approved.

That means "dividend issues will remain overhang" and the resubmission of these capital plans could be a negative sign of dividend payments beyond the third quarter, said Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods, who covers major banks.

Kleinhanzl said he did not expect the Fed to publish new scenarios or make decisions about resubmitted capital plans until the end of the third quarter, until after the November presidential election.

What these scenarios ultimately look like is initially unknown.

"What happens in the economy between now and [later in the third quarter] is of the greatest importance," said Kleinhanzl. "It will have a certain impact on how stressful these scenarios are."

Analysts at Robert W. Baird and Co. said in a message to customers on Friday that the Fed is likely to keep a "short leash" for all bank dividend plans. Baird analysts assume that most banks will keep dividends in the status quo, but said Wells Fargo "likely to see a dividend cut".

Wolfe Research analysts and Janney Montgomery Scott analysts calculated that only two banks, Wells Fargo and Capital One, currently had dividend stocks higher than those approved by the Fed and had the highest chance of making cuts.

"While bank dividends appear to be largely safe for the time being, we would like to point out that the company has not yet received the all-clear, as the restrictions are reviewed every quarter," said Wolfe Research analysts.

The Fed's message about dividends is clear, said Christopher Marinac, an analyst at Janney Montgomery: The current profits of individual banks must support current dividend distributions.

"It's like the Fed is reminding us what we should really focus on – what are the current gains and where are we in this recession?" he said. "And it's very open at the moment."

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