Fed Tells Big Banks to Cap Div Payouts, Limits 3Q Buybacks

Vito J. Racanelli

After the excitement of Fed testimony before Congress, the previous week, it was a fairly quiet time last week for Fed watchers in terms of the standard weekly speechifying.

Still, the Fed is the Fed and there’s a reason they say not to fight it. The Federal Reserve came out with its annual and eagerly awaited stress tests Thursday. And while the health of the nation’s banking system passed muster with the Fed’s oracles, the central bank managed to drop the bank stops.

That’s easy when you say, among other things, that you are asking banks to cap their dividends. In a nutshell, the Fed said the country’s big banks are healthy enough to survive the coronavirus-induced recession but could suffer 2008-style losses if the economy languishes. Automatically, I’m wondering what was the purpose of all the post 2008 regulations then? Let’s move on.

The Fed also said the central bank could take additional steps to restrict buybacks or dividends ‘if the circumstances warrant.’ Now you know why the bank stocks took a bath.

The Fed warned a prolonged economic downturn could saddle them with hundreds of billions of dollars in losses on soured loans. That’s clear enough. It put the worst-case scenario, with a prolonged recession and unemployment, at as much as $700 billion in loan losses. That would erode the capital buffers meant to keep them on stable financial footing, the central bank said.

So the Fed told banks to cap shareholder dividend payouts to preserve capital. Banks, which will soon announce their dividend plans for next quarter, won’t be able to make payouts that are greater than their average quarterly profit from the four most recent quarters.

And a better Fed move was banning banks from buying back shares for the third quarter. In any event most of the largest banks had previously agreed to halt buybacks during the second quarter, showing some common sense. Buybacks are the largest part of capital distributions of U.S. banks. One could, and should, argue of course that buybacks that serve to obfuscate executive pay—which is a large part of it—should be banned. That prerogative, however, belongs to the boards. They are evading their responsibilities in many cases, giving the Fed the ability to step in and order them to do what’s common sense for shareholders.

The Fed believes restricting payouts would help keep banks healthy during the recession. The central bank also threatened to take additional steps to restrict buybacks or dividends “if the circumstances warrant.” Well, I don’t know how bank stocks are going to do from here for the next little while.

Well, I guess it could have been worse. Most Fed officials projected the economy would contract by anywhere between 4% and 10% this year.

The yield on the benchmark 10-year U.S. Treasury note dropped sharply last week to about 0.64% vs 0.69% one week previous. Next FOMC meeting on July 28-29.

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Vito J. Racanelli
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