Many of the biggest American banks that were hard hit by the financial crisis once again had solid profits last year and are eager to resume paying large dividends to their shareholders. But in the post-crisis world of regulation, they can’t do it without an okay from skeptical Federal Reserve officials – in a bid to prevent a repeat of the disastrous mistakes of the past.
Take J.P. Morgan Chase, widely regarded as well managed and less damaged by the crisis three years ago than its peers. The banking goliath announced last month that it earned $17.4 billion in 2010 on revenues of $104.8 billion. Before the announcement, chairman and CEO Jamie Dimon said, “We’re going to be building up a lot of excess capital. So, we would like to restart a dividend.”
When asked at a press conference how big the dividend increase might be, Dimon replied, “Why don’t we just wait and get the guidance from the Fed.”
Indeed, for J.P. Morgan Chase and other large banks, it’s not just a question of how big future dividends ought to be, but also if and when. As Federal Reserve governor Daniel K. Tarullo, the Fed’s bank regulation expert, said in a speech late last year, the response to requests to resume dividends “will be a conservative one.”
As it should be. During the financial crisis the Fed and other regulators were far too lenient in allowing banks obviously in trouble to squander much needed capital by continuing to pay it out to shareholders. The banks should have been retaining the earnings to absorb the looming losses tied to real estate, complex financial instruments such as credit default swaps and risky loans made during the cash-rich boom years. Some institutions, such as Citibank, survived only because of huge infusions of government capital under the Troubled Asset Relief Program and loans extended by the Fed.
Later all the big banks were forced to raise money from investors to repay the government and rebuild their ravaged capital structures.
Meanwhile, negotiators from many countries including the United States met in Basle, Switzerland, to hammer out a new agreement--known as Basle III--on capital adequacy requirements for large, internationally active banks. That agreement, which is to be implemented over several years, calls for such institutions to have a minimum ratio of equity capital to assets of 7 percent. At least a 4.5 percent ratio is needed for a big bank to be considered viable, with another 2.5 percent to be held to cover losses in bad times.
Tarullo said that the 2.5 percent buffer is “designed to forestall banks from continuing to pay dividends even as they come under stress, a practice observed in some institutions during the financial crisis. Realistically, both regulators and markets will expect firms generally to maintain their common equity ratios above 7 percent.”
For the largest, so-called systemically important banks, the Fed and other U.S. regulators want an even higher capital ratio as a cushion to keep them from going broke with potentially ruinous effects on financial markets. The precise figure is still under negotiation as one of the large array of rules being drafted to flesh out details of the Dodd-Frank financial regulatory reform law passed last year.
In J.P. Morgan Chase’s financial report last month it estimated that under Basle III rules it had a 7 percent common equity capital ratio at year’s end. The new Basle III rules won’t be fully in force for several years, but U.S. regulators want them implemented as soon as possible and they want to raise that 7 percent figure by a percentage point or more.
To give bankers like Dimon guidance about dividends, the Fed is requiring any institution that wants to raise their payouts to conduct stress tests to clarify how the banks would fare in a more difficult economic and financial environment specified by the Fed. A broader set of tests took place two years ago with a goal of determining how much additional capital each bank needed to raise. Those results were made public. This time they won’t be made public when they are available in March, because the goal relates to the more limited issue of dividends.
Certainly J.P. Morgan Chase, which paid shareholders 20 cents a share last year, will be among the first group of banks raising dividends. Well Fargo & Co. is likely to be another. It earned $12.4 billion on revenues of $85.2 billion in 2010, and it estimated its Basle III common equity capital ratio at 8.4 percent.
Citibank won’t be on the list. Last year Citi earned $10.6 billion on revenues of $65.6 billion, but the bank is only recently finally free of any government ownership, one requirement before dividends can be paid. Citi eliminated its dividend in 2009.
Citi’s chairman, Vikram Pandit, cautioned last month, “We still think 2012 is the right year for us to return capital.”
Bank of America, the largest U.S. bank in terms of assets--it had $2.26 trillion worth at year’s end--is struggling with real estate-related losses. It lost $2.2 billion on revenues of $111.4 billion.
It was announced this week that the bank’s chairman and CEO, Bryan Moynihan, got a $9.05 million bonus in the form of stock that cannot be sold until sometime in the future. The bank paid shareholders a four-cent dividend per share last year.
Moynihan said he expects to raise the dividend in the second half of the year, but that seems to be a stretch given the Fed’s tight approach in approving dividends. Analysts are predicting Bank of America will earn about $14 billion this year--but that’s a projection, not a reality, at this point.
For some other large banks, including Fifth Third Bank, KeyCorp, Sun Trust and Regions Financial, dividends are out of the question. They haven’t repaid all their borrowings under TARP and can’t pay dividends until it is.
Related Links:
Fed’s Second Round of Stress Tests Done in Groups (Reuters)
Risks Abound with Inflation-Linked Bonds (Financial Times)
About That Bank of America Dividend (The Wall Street Journal)
