A financial ripple effect from the COVID-19 pandemic has become the Federal Reserve’s placing a limitation on how much banks can pay out in dividends for at least the third quarter.
The Fed also prohibited banks from conducting share repurchases in the third quarter, which most already had suspended because of realized and projected revenue reductions for fiscal 2020.
The Dodd-Frank Act stress-test requirements are being tested, if not stretched to the point of breaking, for the first time since their debut in 2013 as local and state economies have been restrained by stay-at-home government orders amid the coronavirus pandemic.
The stress tests determine whether the 35 largest U.S. banks have enough capital to weather a significant economic downturn.
The banks represent more than 80% of domestic banking assets.
Analysts say Wells Fargo & Co. and Capital One Financial Corp. are among the banks most affected, including the potential — if not the likelihood — of a dividend cut.
Banks are allowed to disclose their capital spending plans after the stock market closes Monday.
The Fed released Thursday the first required stress test for 2020. Wells Fargo disclosed its results Thursday, while Truist Financial Corp. had not as of Friday.
However, portions of Truist’s results were provided in the main Fed stress-test report.
The severe downturn time frame is the first quarter of 2019 to third quarter of 2021.
The pre-pandemic downturn metrics included: an 8.5% decline in real gross domestic products from first quarter 2019 to third quarter 2021; 10% U.S. unemployment rate; 28% decline in home prices; 35% decline in commercial real-estate prices; and a 50% decline in the Dow Jones Industrial Index.
The U.S. jobless rate was 4.4% in March, 14.7% in April and 13.3% in May.
Because the current pandemic had led to a more severe downturn, the Fed conducted an additional three stress-test scenarios: a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession.
In those scenarios, the U.S. jobless rate was projected during the measurement period at between 15.6% and 19.5%.
The Fed said that under the U- and W-shaped scenarios, “most firms remain well capitalized, but several would approach minimum capital levels.”
“The sensitivity analysis does not incorporate the potential effects of government stimulus payments and expanded unemployment insurance.”
The Fed said dividend payments during the pandemic would be based on a formula based on recent income.
The board is requiring banks “to re-evaluate their longer-term capital plans” and submit new capital plans later this year “to reflect current stresses.”
“The board will conduct additional analysis each quarter to determine if adjustments to this response are appropriate,” The Fed said.
Wells Fargo projected an overall $23.1 billion revenue loss.
It estimated $26.9 billion in net revenue and requiring a loan-loss provision of $39.9 billion. There also would be $8.9 billion in trading and counter-party losses and $1.1 billion in realized losses on securities and other losses.
The projected losses and net charge-offs again would be spread across several categories totaling $27.7 billion in loan losses.
The bank said it would have a minimum Tier 1 common ratio of 8.8% and a minimum Tier 1 risk-based ratio of 10.4% under the stress test.
Tier 1 common ratio is a measurement of a bank’s core equity capital compared with its total risk-weighted, risk-based capital ratio of 11.1%.
The regulatory minimums are 4.5% for Tier 1 common ratio and 6% for Tier 1 risk-based capital ratio.
For Truist, it projected an $8 billion loss, factoring $11.9 billion in revenue, a $19.3 billion loan-loss provision and $600 million in other losses.
“Banks are capped at their current dividend level, provided it does not exceed 100% of average earnings the prior four quarters,” Janney Montgomery Scott analyst Chris Marinac said. “Two companies that exceed are Capital One and Wells Fargo.
“The Federal Reserve policy on capital distributions clearly enforces the concept that current earnings should support current dividends. Thus, the Fed’s application of recent earnings in the 2020 stress test is consistent.”
Goldman Sachs analyst Richard Ramsden said that “given there is an additional stress test for 2020, coupled with a more onerous dividend payout ratio test, investor concerns around dividend sustainability are likely to persist in the near term.”
Besides Wells Fargo and Capital One, Ramsden included Discovery Financial Services in the category of most likely to make a dividend cut.
He cited also at risk for a dividend cut Ally Financial Inc., Citizens Financial Group Inc., Fifth Third Bancorp, Huntington Bancshares Inc., KeyCorp and Santander Consumer USA Holdings Inc.