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Bank dividends at risk due to macroeconomic situation
There has been quite the back and forth on the question of bank
dividends in the last two months. US banks have not followed their
global counterparts in suspending dividends wholesale. Executives
at major banks have, in the last two months, reiterated their
commitment to dividend payments and are generally opposed to an
order to suspend dividends wholesale.
However, there have been calls by former regulators to require
the banks to suspend dividends to increase their capital buffers
now. The argument being if they shore up now and end up not needing
the capital to support credit in the economy, then they can boost
dividend payments. By not increasing capital buffers now, they'll
have exposed themselves to significant risk and public criticism
should they need tax-payer bailouts later. In this report, we
review the regulatory risks to banks, the strain they may face due
to CECL and COVID-19 provisions, and firm-specific exposures that
could be a source of risk for dividends.
Looking at the entire group, we categorized the banks dependent
on the risk we see to their dividend. Among the banks with the
riskiest dividends are Huntington Bancshares
(HBAN) and Wells Fargo (WFC<span/>). Historically,
Huntington Bancshares (HBAN) has been conservative
with their capital and cut its dividend during the previous
financial crisis to maintain TCE. Both TCE and CET1 are currently
at the lower end of the bank's target range, and the bank has high
(10.6%) exposure to COVID-19 high-impact sectors.
Regulatory & Political Risk
The most substantial risk to bank dividends in the upcoming
quarter is regulatory risk. The Federal Reserve will release the
results of both DFAST and CCAR to the public this afternoon.
Considering the current economic situation, the Fed will be adding
a COVID-19 overlay to the DFAST scenarios that the banks received
in February. If the overlay affects a bank's capital to the extent
that the CET1 to RWA ratio (henceforth, CET1 ratio) does not meet
the required minimum amount, that bank would be limited in the
capital distributions it could make.
The limits on capital distribution differ depending on how far
below the CET1 minimum requirement a bank's ratio drops. For
example, if a bank's CET1 ratio dips slightly below the minimum (up
to 0.625% below requirement), then the bank would be allowed to pay
up to 60% of eligible retained earnings. The farther below the
requirement the CET1 ratio drops, the more stringent the limitation
on capital distributions would become (at 1.875% below the
requirement a bank is no longer allowed to make any capital
distributions). The standard method to determine eligible retained
earnings for capital distributions is to calculate the sum of the
previous four quarters' net income minus any distributions (e.g.
share repurchases, preferred dividends, and common dividends). In
March, to promote bank lending in a time where the economy needed
liquidity, the Fed introduced a more lenient method to calculate
eligible retained earnings determined as the average net income
over the preceding four quarters. If a bank falls below the capital
requirements and has limits imposed on its distributions, then it
can choose whichever of the two methods gives the larger amount of
eligible retained earnings.
Consensus estimates do not currently show any of the DFAST
banks' CET1 ratios dropping below the requirement; however,
depending on the severity of the COVID-19 overlay, the banks'
capital could be impacted to the point where limitations would be
put in place (on a bank-by-bank basis). Because all the banks
suspended share repurchases earlier this year, any eligible
distributions could go toward dividend payments. Taking as an
example the 60% cap - because it the least strict level and none of
the banks are currently estimated to dip into their capital
conservation buffers -- Capital One (COF), Citizen's Financial
Group (CFG), and six other DFAST banks would see their dividends
impacted. With the more stringent 40% limit only nine of the banks
could maintain stable dividends. At the 20% limit, none of the
banks undergoing the DFAST would be able to maintain their current
dividend payment.
Revenue Exposure
Amid the uncertainties associated with the COVID-19 pandemic,
the personal savings rate nearly doubled, and discretionary
spending considerably deteriorated, which implies consumer
conservatism. Consequently, the consumer finance companies remain
under-pressure with less new lending and weakened card
revenues.
Hypothetically, if consumer spending picks up more rapidly, some
banks may have to increase interest rates on deposits to attract
cash, even while the Fed keeps the interest rate at nearly zero. As
a result, the net interest margins would further decline unless the
spreads are effectively managed.
Generally, consumer finance companies and banks tend to align their
dividend distributions to their earnings. Expected earnings
headwinds could, therefore, lead to higher dividend payout ratios
and raise the risk to sustainability.
Contacts:
Amira Abdulkadir, Product Analysis & Design Director
Adi Blanc, Research Analyst
Karandeep Singh, Research Analyst
Email: dividendsupport@ihsmarkit.com
To access the report, please contact
dividendsamer@ihsmarkit.com
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