The U.S. banking sector has roared back to life after a checkup by the Federal Reserve cleared most of the country's biggest financial institutions to start increasing dividends and buying back shares for the first time in years.
Following a nearly five-year freeze on deploying excess capital implemented during the financial crisis, the Fed revealed that most of the 19 banks it ran through rigorous stress tests over the past three months have passed.
Only four financial institutions were told to go back and rework their capital plans.
The moves prompted several of the country's biggest lenders to raise their dividends to levels reminiscent of the days before the financial crisis hit.
JPMorgan Chase & Co. said it would boost its dividend by 20 per cent and immediately embark on a plan to buy back $15-billion (U.S.) in shares.
Wells Fargo & Co. raised its quarterly dividend 10 cents to 22 cents, and said its capital plan also calls for more share buybacks in the next two years. U.S. Bancorp announced a 56-per-cent hike to its dividend, and American Express unveiled plans to boost its payout by 11 per cent. Both also announced planned share buybacks.
"This is really the first positive sign that the banks are back," said Gerard Cassidy, a banking analyst with Royal Bank of Canada's investment arm in the United States. "It's been four and a half years basically since the U.S. banks have had some real good news."
The move by JPMorgan helped push the Dow Jones industrial average up 1.68 per cent to 13,177.68, the highest closing value for the benchmark index since late 2007.
It added to a more optimistic mood, along with a separate analysis by the Federal Reserve earlier in the day that showed the central bank more optimistic on the economic outlook.
Bank of New York Mellon had the highest tier-one common capital ratio of 13.1 per cent, followed by State Street Corp. at 12.5 per cent. Other lenders to pass the stress test included American Express, with a ratio of 10.8 per cent, and Bank of America at 6.2 per cent.
The stress tests looked at how 19 financial institutions planned to manage capital over the next nine quarters, and subjected their plans to hypothetical scenarios involving a deep recession to see whether their balance sheets could withstand the pressure. Among those scenarios was a hypothetical drop in housing prices by more than 20 per cent and a rise in unemployment to 13 per cent.
The stress tests called for a minimum ratio of tier-one common equity of 5 per cent to be maintained. Tier-one common equity is considered to be the most liquid assets that can offset a bank's lending operations in a crisis.
While large banks such as JPMorgan and Wells Fargo were among those that exceeded the minimum requirements, even with plans to increase dividends and share buybacks factored in, four financial institutions didn't meet that threshold.
Capital plans submitted by Citigroup Inc., Ally Financial, SunTrust and MetLife Inc. did not meet the 5 per cent threshold, meaning if they pursued planned dividend increases and share buybacks under the stress scenario, their ratios would have fallen below that level. Ally Financial was the lowest at 2.5 per cent, while Citigroup was 4.9 per cent and SunTrust Banks was 4.8 per cent.
Those banks will now be forced to go back to the drawing board to come up with revised capital plans to be submitted to the Fed.
"Projections are based on a hypothetical, severely adverse macroeconomic and financial market scenario developed by the Federal Reserve, featuring a deep recession in the United States," the Fed said in its report.
"The purpose of requiring [banks]to develop and maintain these capital plans is to ensure that the institutions have robust, forward-looking capital planning processes that account for their unique risks and that the institutions have sufficient capital to continue operations throughout times of economic and financial market stress."
The official results of these stress tests weren't supposed to be made public until later this week, but several of the reports began to leak on Wall Street after banks were informed of their individual performances Tuesday afternoon.
Investors have been pushing for increases in quarterly dividends to pre-crisis levels, and for a return to share buybacks, which were also put on hold as a condition of the U.S. government bailouts of the banking sector after the 2008 banking crisis.
"We are pleased to be in a position to increase our dividend and to establish a new equity repurchase program," JPMorgan chief executive officer Jamie Dimon said in a statement. "We expect to generate significant capital and deploy that capita to the benefit of our shareholders."
Citigroup said its capital is among the strongest in the world, and it plans to discuss the Fed's model with the central bank.
The fourth financial institution to miss the grade was insurance giant MetLife Inc. The largest U.S. life insurer fell short of the Fed's standard regarding risk-based capital, a subcategory of the overall stress test. MetLife had 6 per cent, while the Fed requires 8 per cent.
"We are extremely disappointed," MetLife CEO Steven Kadarian said in a statement, saying that the methodology is a better way of judging bank capital than for an insurance company.