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Some bank dividends at risk as Fed weighs action


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Some bank dividends at risk as Fed weighs action

As federal regulators face questions on whether they should suspend big banks' dividends, some smaller banks have already cut their payouts to shareholders and analysts are mapping out others that may soon follow suit.

The topic has continued to gather steam given the rapid deterioration in the U.S. economy, which has already shed all the jobs created over the last decade and whose unemployment rate may soon rival Depression-era levels.

Bank balance sheets came into the current downturn far healthier than the 2007-09 financial crisis, when banks' capital levels proved far too low to withstand losses, forcing many to turn to the federal government for help. But Democrats and some former top regulators, including former Fed Chair Janet Yellen, have said the Fed should halt banks' dividend payments to shareholders partly because credit losses may be more severe than banks have planned for.

At least 19 smaller and midsize banks have lowered their dividends amid the coronavirus pandemic, according to an S&P Global Market Intelligence review. That includes South Dakota-based Great Western Bancorp Inc., Indiana-based 1st Source Corp., and the California-based banks Hanmi Financial Corp. and PacWest Bancorp.

Analysts' chatter is picking up as to who may be next. Although Keefe Bruyette & Woods Inc. analysts wrote that they see bank dividends as "broadly safe," they flagged Wells Fargo & Co. as a candidate to cut dividends along with a few larger regional banks: Citizens Financial Group Inc., CIT Group Inc., Comerica Inc. Huntington Bancshares Inc. and KeyCorp.

Those banks' dividend payout ratios and other similar metrics are elevated compared to some of their peers, an indication that their current dividend payouts may be less sustainable when compared to their future earnings, the KBW analysts wrote in a May 13 research note.

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Quarles 'open-minded' on dividends depending on stress test results

Regulators may decide to step in first, at least for the large banks undergoing their stress tests this year.

Fed Vice Chairman for Supervision Randal Quarles said during his recent congressional testimony that the Fed would be "open-minded" on the issue depending on banks' stress test results. Analysts noted those comments were less definitive than past remarks from Fed Chairman Jerome Powell, who said April 9 that suspending bank dividends is "not something that needs to be done at this point."

If the Fed does take action, its announcement would likely be part of this year's stress tests. The Fed is reviewing 34 banks with more than $100 billion in assets under the annual process, which typically wraps up by the end of June, but which Quarles has said will likely be completed sooner. This year's examinations, which looked to test banks against a hypothetical downturn with an unemployment rate peaking at 10%, proved too tame compared to the actual economic shock that the coronavirus is posing. The Fed said it is adding "sensitivity analyses" that will incorporate the COVID-19 shocks in the tests.

The Federal Open Market Committee, which includes the central bank's 12 regional presidents, discussed bank dividends at its April meeting. Although regional Fed officials do not vote on regulatory policy, the minutes showed that a number of FOMC participants believe regulators should encourage banks to prepare for downside scenarios by limiting shareholder payouts and therefore "preserving loss-absorbing capital."

"Indeed, historical loss models might understate losses in this context," the minutes said.

Kristalina Georgieva, the head of the International Monetary Fund, also wrote a Financial Times op-ed calling on banks around the world to suspend their dividends or for supervisors to "take the decision for them" if the institutions are reluctant to do so.

An across-the-board suspension of large banks' dividends from the Fed may punish those institutions that have enough capital available to keep paying dividends, and it would risk unnecessarily creating a "crisis in confidence" in the industry, said Gerard Cassidy, head of U.S. bank equity strategy at RBC Capital Markets.

"It changes the narrative to fear and worry over a banking system that is right now very strong, healthy [and] liquid — a system that has rebuilt itself from the lows of 2008-09," Cassidy said.

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The Bank Policy Institute, a trade group that represents larger banks, also wrote that a "government-mandated dividend halt" would harm everyday investors that rely on bank dividends as an income source and make stock investments in healthy banks less attractive. Banks' dividend payments have not restricted their ability to keep making loans, even after the adoption of a new accounting standard this year prompted large banks to build up reserves ahead of potential loan losses, the group wrote in a May 15 blog post.

Those who argue for an across-the-board suspension of bank dividends say the Fed is in a unique position to force banks to take collective action, given that individual lenders may be wary of halting dividends by themselves.

Banks should have prepared investors for potential dividend cuts on their own through a "massive public relations" campaign, said Mayra Rodríguez Valladares, managing principal at the consulting firm MRV Associates. While JPMorgan Chase & Co. CEO Jamie Dimon has mentioned scenarios under which the country's largest bank would consider suspending dividends, other major banks have yet to publicly prepare shareholders for that possibility.

The longer they wait, the more likely investors "will be shocked and punish" their stocks if they do cut their dividends, Rodríguez Valladares said.

Asked about the issue at a Deutsche Bank conference on May 26, Dimon said it is important for companies to try to sustain their dividends and that they are a "drop in the bucket" compared to banks' share repurchases, which big banks suspended in mid-March. The base-case scenario among economists is that the economy will likely begin to recover in the second half of the year, limiting losses at banks and therefore making dividend cuts unnecessary, Dimon said.

Banks should weigh their options if there are any signs that the credit cycle will "get worse dramatically" from here, but most are well-capitalized, and the numbers may not justify a dividend cut, he said.

"If a board is mature, they'll consider that," Dimon said. "But you have to have a pretty bad economic environment, I think, for banks to justify to their boards and to show that we should cut it now."

Large-bank dividend cuts would spill over to smaller lenders

If larger banks do cut their dividends or the Fed forces them to, the impact would likely "trickle down" to smaller lenders and prompt them to reevaluate their dividends, said Jennifer Demba, a bank analyst at SunTrust Robinson Humphrey who mainly focuses on smaller regional lenders. Her coverage sphere includes banks like Houston-based Cadence Bancorp., which has roughly $17.2 billion in assets and slashed its dividend to 5 cents per share from 17.5 cents per share.

A few other similar-sized banks may choose to cut their dividends in the near-term, though they may hold off until the second half of the year when loans currently in deferral may turn into charged-off loans, Demba said.

Still, dividend cuts will likely not be widespread given that most banks are positioned to "be able to earn through this downturn," she said.

"They're definitely not earning ... what they thought they were going to earn at the beginning of the year," she said. "But it looks like most of the banks we cover should be able to cover their dividends."

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