(Bloomberg News) Citigroup Inc. and Bank of America Corp. are among lenders that may have to temper plans to raise dividends and buy back stock next year as the Federal Reserve toughens capital tests for the biggest U.S. banks.
The Fed imposed a tougher capital test on the 31 largest U.S. banks yesterday, releasing the criteria for measuring their wherewithal if the U.S. economy sours and major trading partners default on their debt. Lenders need to prove they have the capital to withstand a "severe" U.S. recession with 13 percent unemployment and an 8 percent decline in gross domestic product before they can increase dividends or repurchase shares.
The more pessimistic scenario will damp banks' ambitions to return more capital to shareholders, whose holdings have been decimated. The KBW Bank Index of 24 U.S. lenders has plunged 31 percent this year through yesterday and is down 70 percent from its all-time high in February 2007.
"It's going to be very difficult for any of these companies to do any major buybacks into next year," said Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia and an analyst at FBR Capital Markets Corp. in Arlington, Virginia. Bank of America and Citigroup's "chances of upping a dividend or buying back any stock next year are almost zilch."
The Fed limited banks to returning 60 percent of their retained earnings to shareholders in 2011, split evenly between dividends and share repurchases. Glenn Schorr, an analyst at Nomura Holdings Inc., said banks may possibly be restricted even further, to about 40 percent, under the more adverse scenario.
'That's A Disaster'
"The tighter you stress and the more extreme you stress, the more careful you'll be in terms of letting banks return capital," Schorr said in a phone interview.
The Fed's stressed scenario calls for unemployment to hit 12 percent by next year and 13 percent in 2013. It also tests banks' performance in an economic decline that begins this quarter and bottoms in the first quarter of next year, with real gross domestic product falling 8 percent and home prices dropping 20 percent during the next two years.
"An 8 percent decline in GDP, that's a disaster," Miller said. "That's not a recession."
The so-called supervisory stress scenario used earlier this year examined how lenders would fare if U.S. unemployment climbed to 11 percent, real gross domestic product dropped 1.5 percent, house prices fell 6.2 percent and stocks plunged 28 percent by year-end. The jobless rate has remained near 9 percent all year.
JPMorgan, Goldman Sachs