US stress tests: good news for dividends, less so for buybacks

America’s largest lenders have once again sailed through the Federal Reserve’s annual stress tests. The banks in this year’s test proved (on paper) that they have enough capital to weather a cocktail of market and economic shocks. These include a 10 per cent unemployment rate, a 40 per cent collapse in commercial real estate prices and a 55 per cent plunge in stock prices.

For bank investors spooked by growing recession fears, nerves will be soothed by the Fed’s scenario. This assumes $612bn in collective losses, far more extreme than anything economists predict for next year. Unfortunately, receiving a passing grade will not necessarily encourage all banks to shower more cash on their shareholders via dividends and share buybacks.

Some banks ended up faring better than others on the test. Losers include Wall Street banks with large retail banking operations — JPMorgan, Bank of America and Citigroup. These now have capital requirements that are nearly 1 per cent higher than before.

This means they may have to raise their internal target ratios and hold off on stock buybacks to increase their Common Equity Tier 1 ratios. No need to expect dividend cuts. But these payouts are also unlikely to materially increase.

Next week, banks will start outlining the size of their capital return programmes for this year. Investors will do well to temper their hopes for bumper payouts. Goldman Sachs now expects the three banks to return $35bn in combined dividends and share buybacks this year. That is well down from the $66bn it had pencilled in at the start of January.

Despite Friday’s rally, shares in the big Six — JPMorgan, Bank of America, Morgan Stanley, Goldman Sachs, Wells Fargo and Citi — are down around a quarter this year. Only JPMorgan, BoA and Morgan Stanley trade above their book values. Without the lure of bigger payouts, expect bank shareholders to have their own stress levels tested.