Excess capital in 2019 stress tests allow banks to hit dividend payout targets
Ordinary payout from US banks is expected to increase by 6.5% to $44.7bn
- Easier stress test scenarios compared to 2018 were positive for dividend increases according to the results of the Federal Reserve's annual exams, despite the decrease in the number of firms
- All 11 US banks passed with Goldman Sachs (GS), PNC Financial Services Group (PNC) and State Street Corporatoin (SST) exceeding our expecations
- Tougher card loss model placed Capital One Financial Corporation (COF) YoY dividend growth at risk, and will reverberate for firms in the extended stress test cycle in 2020
The Federal Reserve released the 2019 Dodd Frank Act Stress Test (DFAST) results on June 21 and the Comprehensive Capital Analysis Review (CCAR) results on June 27. DFAST highlights how much capital banks will have available after stress tests to deliver on their dividend distributions for FY19 Q3 through FY20 Q2. The release demonstrated that all but two banks in our US coverage reporting on DFAST would hit our estimates for dividend hikes in Q3. We have observed that many of the banks tend to increase their dividend at the Q3 stage following the results.
Wells Fargo & Company (WFC) and State Street Corporation (SST) announced the highest increases to their 12-month forward dividend yield of 4.41% and 3.74%, however, reports from the overall group did contract from the previous year, lessoned by modest increases at Bank of America Coporation (BAC), Citigroup (C), and PNC Financial Services (PNC). Most companies are yielding dividends above 3%.
Extended Stress Test Cycle Presents New Top Payers
Fewer firms participated in the 2019 stress test cycle, falling from 35 last year to 18 this year. The biggest increases last year were driven by SunTrust Banks (STI), Regions Financial Corporation (RF), and Citizens Financial Corporation (CFG), who are part of the latter group and will next undergo CCAR in 2020. Rather, the banks that increased their dividend less than 5% in CCAR 2018 wound up driving dividend growth in CCAR 2019 with a median YoY increase of 18% amongst US banks.
The easier stress tests underpinned a significant part of the growth in aggregate payouts. The 18 banks tested comprise approximately 70% of the total assets of all US financial services companies and contribute to 82% of aggregate dividends paid by the sector. For instance, median US banks saw stressed CET1 ratios up 2.5% and Tier 1 up by a median 80bps under the Federal Reserve's adverse scenario. This had a meaningful effect on banks' payout ratio, which rose from 21% in CCAR 2018 to 32% in 2019. The minor difference is attributed to the less restrictive inputs.
Stressed ratios increased most from last year for State Street Corporation (STT), Bank of America Corporation (BAC), Morgan Stanley (MS) and Citigroup (C), who we note kept their dividend flat Q-o-Q, or increased $0.04-$0.05 YoY, in line with previous year's trend. Both JPMorgan (JPM) and Capital One Financial Corporation (COF) submitted adjusted capital actions to the Federal Reserve to ensure their projected CET1 met the minimum 4.5% stipulated by the Board. The respective 70bps and 20bps adjustment favourably impacted JPM's dividend, permitting an increase of 13% YoY.
In our forecasts we assumed Goldman Sachs (GS) would only slightly increase their dividend by $0.05 in Q3, a staggering difference from the $0.40 increased announced by the company on Thursday, June 27. The potential fines related to 1MDB attributed to our projected aggregate payout of $1243m in FY19 Q3 - FY20 Q2. The CCAR results suggest that GS can continue to surprise shareholders positively through capital returns. GS's stressed capital buffer increased 130bps further supporting the firm's ability to pay the dividend and accumulate capital to weather any penalties.
Refinements to the Credit Card Model Prompt Flat Payments
Contrary to our estimates, Capital One Financial Corporation (COF) neglected to increase its dividend YoY following its submission of an adjusted capital action plan in June. In the last cycle, their dividend arrived within 1bps of the minimum, while this year they projected an increase in their minimum capital ratio to 8.5% and 9.1%. However, the possibility of suffering the greatest total loan loss rates of 16% - significantly above the median of 4.7% for the group - highlights the possibility of declines or stable rates in the 2020 CCAR payouts. We anticipate industry peers like Synchrony Financial (SYF) and American Express (AXP) will factor these loss rates into their 2020 capital plans.
The remaining 17 firms will participate in the extended stress test cycle, at which point we project super-regional banks will increase their dividends a comparable 6.5% over FY18, from $16.7bn to $17.8bn. We anticipate that the credit card loss model introduced by the Fed last year will meaningfully contribute to increases in projected minimum credit card book losses, negatively impacting American Express (AXP)'s ability to increase their dividend. We are projecting an 8% increase from last year, from $0.39 to $0.42, considering the company's adjusted capital actions last year that increased minimum CET1 from 4.4% to 5.0% in June, making the $0.03 increase realizable. Although their capital plans will not be scrutinized until later this year, the recent dividend announcement of $0.44 from Discover Financial Services (DFS) coincided with the June results release; breaking their trend of making $0.05 increases per annum since FY16, indicating that the change in criteria since last year has negatively impacted dividends paid by card services providers.
The reduction in the number of firms did not deter dividend growth from the largest dividend payers in the sector, but reoriented expectations for upcoming CCAR cycles. Dividend increases were made by 10 of the 18 banks and the median payout ratio from the group is expected to remain between 30-40%, a preferred target range for banks when their management issues guidance. The latest iteration of CCAR results indicates that banks are predicted to deliver healthy dividend growth through June 2020 based on the strong DFAST results.
Posted by Dividend Forecasting at IHS Markit
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