Wall Street Dividends Will Be Impacted by Virus Pain, Fed Says

(Bloomberg) -- Wall Street banks should brace for their dividends to be influenced by adjustments to the annual stress tests that the Federal Reserve made due to the coronavirus pandemic’s economic upheaval, Fed Vice Chairman for Supervision Randal Quarles said Friday.

The exams help the Fed set the most important capital demands imposed on the largest U.S. lenders -- and they are instrumental for banks in setting shareholder dividends. Next week’s results could see drama as the first to be calculated while a real crisis is raging.

“We simply would not have been doing our jobs if we had just run the test using a scenario framed before the economy began to deteriorate in March,” Quarles said in an online event hosted by Women in Housing & Finance.

Though the Fed didn’t have time or data to run a “complete and updated” Covid-19 stress test, Quarles said, it did amplify some key parts of the pain that banks were subjected to under the existing scenarios, which included severe pain in the corporate debt market and a significant jump in the unemployment rate.

“This sensitivity analysis has helped sharpen our understanding of how banks may fare in the wide range of possible outcomes,” Quarles said in his prepared remarks.

Pandemic Analysis

While the banks’ main capital targets will be set in the normal way, according to existing rules, he said, the separate pandemic analysis has been conducted by Fed staff to get a sense of how lenders may be weathering the crisis depending on a few different potential paths for the current recession.

“We will use the results of our sensitivity analysis to inform our overall stance on capital distributions and in ongoing bank supervision,” he said.

Though megabanks have continued paying dividends to shareholders, they’ve made what Quarles called a “prudent” decision to suspend stock buybacks during the coronavirus crisis. Democratic lawmakers and consumer advocates have said lenders should temporarily suspend dividends and use their capital to help absorb the financial strains on the economy.

In the stress-test results to be released June 25, the usual capital scores will be apparent for each firm, but the outcome of the pandemic exams will only be released at an industrywide level. Banks will then be directed to look at their individual results and announce their capital plans -- including dividends -- by the end of the day on June 29, according to a footnote in Quarles’s speech.

Capital Targets

In August, the Fed will release the capital targets that banks must reach by the fourth quarter and maintain until the next round of stress tests. When asked whether the agency would make any sweeping decisions on dividends, Quarles said it’s “important not to ignore” the process already in place for deciding how much capital banks can afford to give to shareholders.

Each year’s stress tests pose hypothetical crises to gauge banks’ ability to weather financial shocks. But the scenario released in February came before the nation’s economy was largely shut down by the coronavirus, and the balance sheets to be tested were from the end of last year -- also predating the pandemic. The impact of the Covid-19 crisis has been more extreme than what the Fed usually creates.

The silver lining is that the banks no longer face public pass-fail announcements associated with the tests. They’ve also been redesigned under Quarles’s watch to mesh closely with the other capital demands, directly translating each bank’s stress-test losses into a buffer.

©2020 Bloomberg L.P.