… same as the old Fed stress tests.
At least that’s the prediction of Nomura’s Glenn Schorr, whose note published on Thursday plays down any expectations that the forthcoming Comprehensive Capital Analysis and Review (CCAR, or “stress test”) will lead to increases in share buybacks or dividends.
Reminder: the stress test process involves US banks submitting plans for how they intend to use their capital in the coming year. The Fed then looks at the following five areas of the plan:
1. Capital assessment and planning processes;
2. Capital distribution policy;
3. Plans to repay any government investment;
4. Ability to absorb losses under several scenarios; and
5. Plans for addressing the expected impact of Basel III and the Dodd‐Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd‐Frank Act)
Based on its assessments, the Fed makes judgements about the amount of dividends and repurchases banks are able to provide. In March, last year’s stress test said that “firms generally are expected to limit dividends to 30 percent or less of anticipated earnings” and “Planned share repurchases will be reviewed if there are material adverse deviations from the revenue and loss assumptions in a firm’s capital plan such that capital is not increasing as anticipate”. Schorr isn’t expecting much change in these expectations this time around.
Results aren’t expected until March but we should get the Fed’s macro assumptions before Thanksgiving (for non-American readers, that’s Thursday November 24th). “Given the still tepid macro environment, we expect CCAR’s stress test scenario assumptions to remain at least as conservative as the prior year”, Schorr writes. As a reminder, here are last year’s scenarios:
Bears would argue that these scenarios are too rosy, and they might be right but you know how we feel about forecasts. Of more concern to us is that the Fed, in these tests, takes into account declining net interest margins and exposure to European sovereign debt and banks.
Schorr is chiefly interested in whether the Fed will allow particular banks more freedom for buybacks and dividends. And, like last time around, he’s not expecting any one bank to receive special treatment:
Last year, we noted very little differentiation in the CCAR process among banks with higher absolute capital levels. Those banks receiving approval appeared to have been limited to 50-60% total payout ratios on a somewhat blanket basis. STT noted in its recent investor presentation that the, “median payout ratio for those banks that participated in the CCAR stress test and were able to increase dividends and repurchase shares was 58.6% of consensus earnings”. Bank capital returns plans are thus handcuffed by CCAR approval and probably frustrating those banks with the highest absolute capital levels (like JPM, STT, NTRS, and GS). Unfortunately, while some banks are in better shape than others, we are not optimistic this year will be any different, given the larger number of institutions involved and the relatively short decision timeline. Last year, the CCAR process covered 19 firms, which has been extended to all bank holding companies with more than $50 bn in assets this year.
This, adds Schorr, is what happened in the early 1990s when regulators “were similarly cautious on payout ratios and did not differentiate much by banks”. In the figure below (click to expand) he shows how this tightened payouts in the early 1990s, and also how payouts exploded in the pre-crisis era. Happy days, remember?
Apropos of nearly nothing, Schorr’s appendix contains an interesting chart, too. The chart is designed to show you that US banks have been behaving themselves and it is a shame that more capital can’t be returned to shareholders. But we can’t but stare at the French bar…
Related link:
Treasury yields testing bank limits – FT
US banking stress tests 2.0 – an update – FT Alphaville