Big U.S. banks await OK to deliver dividends to shareholders

What will President Trump mean for stocks?
What will President Trump mean for stocks?

Investors are set to find out whether America's biggest banks are cleared to give them a hefty dividend boost.

The Federal Reserve on Wednesday will disclose if 34 of the country's banks will be granted permission to buy back stock or pay dividends to shareholders.

The verdict is part of the Fed's yearly financial health checkup on banks like JP Morgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC) to determine if firms are strong enough to weather a severe financial crisis while still being able to continue to lend to consumers and businesses.

It will be up to individual banks to detail exactly what those capital plans will be.

Related: America's banks are really, really healthy

Last week, banks were given a clean bill of health in the initial round of "stress test" results. The Fed said the biggest banks would be capable of continuing to lend, even under dire economic conditions -- in this case, a 10% unemployment rate, a sharp decline in housing prices and a severe recession in the eurozone.

"We expect more positive news for large cap banks," wrote Brian Gardner, an analyst with Keefe, Bruyette & Woods in a note to clients ahead of the second round of results. He said last week's findings affirmed the strength of banks, "which could lead to good news regarding capital deployment."

Jaret Seiberg, an analyst with Cowen & Co.'s Washington Research Group, said the biggest risk could be that banks "were too conservative" in their dividend and buyback requests to the Fed. "Otherwise, Wednesday should be a positive day that shows the banking industry is strong."

He expects "materially higher distribution levels" for most of the banks, he wrote. "This means higher dividend rates and larger buybacks than in prior years.

Related: The world's riskiest bank is in trouble

This is the seventh year in a row the Fed has run stress tests, which were put in place after the financial crisis.

The Fed's annual checkups have long made banks jittery. However, regulators continue to tweak the exam to make it less onerous.

Regulators look for two key pieces of information. One is whether banks have enough capital to survive economic turmoil in the financial system. And the other is whether firms were good at identifying and measuring risk when they craft their plans to pay dividends or buy back shares.

The Fed can reject a bank's capital plan for either reason.

Any bank that fails must draw up new plans and won't be allowed to pay dividends to shareholders until a plan has been approved.

Banks had the chance to revise their capital plans ahead of this week's results. It's unclear if any have done so.

Related: Trump gives banks (a lot of) what they want

Earlier this year, the Fed eased the exam on 21 banks with $250 billion or less in assets. These banks will only have to meet certain capital thresholds to "pass" and won't be judged on their ability to foresee risk when drafting plans to offer share buybacks and dividend payments.

Removing regulators' ability to "fail" a firm for its inability to gauge risk makes it more likely a firm will pass the test, according to analysts.

"There is little threat of a failure," Seiberg wrote.

Fed officials are considering making similar changes to the tests for the largest U.S. banks like Goldman Sachs (GS), Morgan Stanley (MS) and Citigroup. (C)

Related: Regulators ask Congress to give small banks a break

Jerome Powell, the Fed's interim regulatory czar, told Senate lawmakers last week if the country's largest banks continue to meet regulators expectations, it would be "appropriate" to remove the subjective aspect of the yearly test altogether.

Powell's suggestion comes amid more than 100 recommendations made by the Treasury Department to lessen the burden on banks, including limiting the number of financial firms that must face the annual exams.

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