Stress test gives banks room for dividend increases before capital rule changes

A round of dividend increases by big US banks followed stress test results that were better than expected, and that gave the group a bit more of a cushion to absorb anticipated increases in capital requirements from forthcoming regulatory proposals.

Among a group of 11 banks subject to this year's stress test and have made announcements, nine announced dividend increases and none announced reductions, according to data compiled by S&P Global Market Intelligence. Wells Fargo & Co. led the way with a 16.7% increase.

More banks also reported declines in preliminary stress capital buffers (SCBs) — the component of capital requirements determined by the stress test — than reported increases, though the group generally remains cautious over stock buybacks amid uncertainty about the rule changes and even some questions about the stress test results themselves.

"It looks like at least three of the universals will go into whatever changes are to come with a little more breathing room than we would have figured just a few days ago," Piper Sandler analysts said in a note on July 2.

Questions on results

Both Bank of America Corp. and Citigroup Inc. said they had "initiated dialogue" with the Fed over differences between the stress test results and the ones each bank was required to compute internally.

BofA said the issue was other comprehensive income (OCI), which captures changes in the fair value of some bond holdings along with other factors including the impact of some hedges. The parameters for the stress test included a sharp and sustained drop in interest rates, which is generally associated with an increase in the value of bonds, and the Fed's results showed an OCI benefit of $22.3 billion for BofA, or 1.4% of the bank's starting risk-weighted assets. By contrast, BofA's internal results were worse, showing an OCI hit of $1.7 billion, or 0.1% of starting risk-weighted assets.

BofA's results also showed much lower pre-provision net revenue of $29.0 billion, versus $43.2 billion from the Fed's results. Overall, the Fed's results showed only a 0.6 percentage point drop in BofA's common equity Tier 1 (CET1) ratio to 10.6% from start to minimum, implying an SCB requirement at the floor of 2.5% — less than BofA's current SCB requirement of 3.4%. BofA's internal results showed a starting-to-minimum drop of 2.9 percentage points.

Citi said it had approached the Fed over its simulated noninterest income, which the central bank put at $43.9 billion versus $64.4 billion under Citi's internal results. Citi also said the central bank's results indicated an SCB of 4.3%, up from 4.0% currently, and announced that it is raising its dividend by 3.9% to 53 cents a share. It said it had repurchased $1 billion of stock during the second quarter, in line with previous guidance.

SCBs, which mostly reflect simulated deterioration in CET1 ratios, are set according to the results the Fed determines.

Dividend increases

"The stress test results were a general relief," analysts at Jefferies said in a July 4 note, though they and other analysts said the dividend announcements were not far out of line with expectations.

Data compiled by Jefferies on 16 banks in their coverage universe found the new dividends were above consensus forecasts for the next 12 months in six cases and below consensus forecasts for an equal number.

PNC Financial Services Group Inc. was among the banks saying its stress capital buffer will fall — from 2.9% to 2.5% — and the bank announced a 3% increase in its dividend to $1.55. It also said it expects its share repurchases to slow in the third quarter relative to recent periods because of anticipated proposals from regulators to toughen rules. Analysts at Piper had expected a flat dividend and called the increase "a nice boost."

– Download a template with data on capital plans at stress test participants. – Download a tear sheet to run a stress test on banks and thrifts. – Download a template to view exhibits from the 2023 stress test results.

Capital cushions

The declines in SCBs give some banks even greater cushions over current requirements than they had going into the stress test.

JPMorgan Chase & Co. and Wells Fargo both "had plenty of excess capital even prior to their new, lower SCB buffers and executed" $3 billion and $4 billion of buybacks in the first quarter, respectively, the Jefferies analysts said. "We expect both to continue buybacks at a similar pace throughout [2023]." JPMorgan Chase's CET1 surplus over its requirement would roughly double to $39.34 billion relative to its current SCB, according to S&P Global Market Intelligence data.

Still, substantial increases in capital requirements could compel some big banks to retain large amounts of additional capital in the coming periods.

"The annual stress test exercise showed a smaller loss than the previous year, which is an upside surprise for the space," BTIG analyst Isaac Boltansky said in a July 1 note. ...With that being said, all of our client conversations remain focused on forthcoming changes to the bank capital framework."