The conviction that increased capital would accomplish little without increased confidence guided the Federal Reserve's response to the financial crisis. The Fed's rationale for approving capital releases shows the banking sector's recovery hasn't changed its thinking.
The central bank's Friday announcement paired quantitative measures with repeated assurances that the system has sufficiently stabilized to allow for standardized, conventional analysis of banks' capital needs. While the document explicitly rejected the notion that capital releases — such as dividend increases and share buybacks — amount to a tacit endorsement of banks' capital and management, it implied that those banks that passed the stress tests have cleared every theoretical hurdle the Fed might throw in front of their return to "normalized" business.
"What investors want to know is that the more the Fed talks about how these guys passed the test, the more they're married to them, therefore it's safer to buy" bank stocks, said Paul Miller, head of financial services research at FBR Capital Markets.
The document does more than make the case that the Fed's capital analysis was rigorous. It lays out what the Fed describes as something close to the pinnacle of supervisory analysis: A crisis-tempered, holistic evaluation that will be consistently used as the capital yardstick for big banks in years to come. The "Comprehensive Capital Analysis and Review," as the Fed branded its evaluation, "represents a substantial strengthening" of central bank oversight, the agency said. It is intended not only to measure capital but to "ensure that large bank holding companies have strong, firmwide risk measurement and management practices."
The Fed's 19-page description of CCAR most immediately served as the starting pistol for a spree of dividend, share repurchase and Tarp exit plan announcements. While none of the largest banks reached the 30% dividend cap laid out by the Fed as an eventual maximum, JPMorgan Chase & Co.'s 25-cent-a-share quarterly distribution got it most of the way there. (Last month JPMorgan Chase released a compilation of analyst projections anticipating $10 billion in buybacks — $4 billion this year and $6 billion next year.) The $15 billion limit on its new two-year stock repurchase program — with $8 billion deployable in 2010 — also gives the company the flexibility to exceed analyst buyback projections through 2012.
As analysts expected, even many companies that didn't announce a major dividend move reported progress. PNC Financial Services Group Inc. and Fifth Third Bancorp both said they had approval for an increase of still-to-be determined size, KeyCorp and SunTrust Banks Inc. laid out concrete Tarp exit plans and even BB&T Corp., which already paid a 15-cent-a-share dividend, added one cent. "They didn't want to be left out of the party," Miller said.
Gerard Cassidy, banking analyst for RBC Capital, said Thursday, before the Fed and bank announcements, that the moves had been relatively well telegraphed. Based on "body language" and other signs, Cassidy said, he and the market anticipated substantive easing on dividend restrictions.
"I think you'll find that just about all of them get some sort of positive read from the Fed," Cassidy said, correctly predicting that Regions Financial Corp. might be an exception. The roots of the process went back all the way to mid-2010, he said, when a handful of banks, led by JPMorgan Chase and U.S. Bancorp, began "champing at the bit" over dividends.
"Regulators discovered they were going to get inundated [with dividend requests], and decided 'we may want to set up a process to control it.' "
In describing how it arrived at the test's final form, the Fed lays out a series of stresses. Some, such as a one-day 30% drop in the price of "risky assets," are draconian on their face. Others, such as an 11% housing decline from the third quarter of 2010, seem less dire.
But while the Fed details the series of macroeconomic mishaps banks could face, its public explanation barely touches on industry-specific threats or structural concerns. There is no mention of the $270 billion in Federal Deposit Insurance Corp. Temporary Liquidity Guarantees still outstanding, a factor the FDIC cited in urging a more cautious hand. Liquidity, in fact, doesn't appear at all. Relative size of the institutions isn't a listed consideration, and threats from mortgage servicing litigation, second-lien portfolios and other supposed bank bogeymen do not appear. While perhaps severe, the hypothetical difficulties in the evaluation are of the sort that would be expected in any major recession. "Everyone talked about how tough the test was, but you just don't know," Miller said, arguing that the macroeconomic stresses listed in the appendix aren't sufficient to understand the Fed's decision-making.
The boundaries of the discussed results don't necessarily mean the Fed is ignoring the possibility of further industry-specific challenges, Cassidy argued. But while there were legitimate countervailing arguments to a large-scale resumption of capital deployments, he said, the benefits of greater confidence in banks were likely seen as outweighing them.
"If we want this economy to start growing, don't we want to attract more money to the banking system?" Cassidy said. "The banks know this is good news, and the Fed knows that it's a signal they're sending to the marketplace that the banking system has recovered dramatically."
