Banks’ big, fat dividends are under fire as profits plunge

“We need a banking system that’s able to meet the credit needs of the economy,” Yellen, who led the San Francisco Fed in 2008, told CNBC last week. “And we don’t know how severe or how long-lasting this pandemic will be.”

Unemployment could spike to 20%

There’s no doubt the banking industry is stronger today than it was a dozen years ago. Lenders are now required by regulators to bulk up vast amounts of loss-absorbing capital and halt the risky practices that fueled the last crisis.

Still, this enormous shock is one that few saw coming.

The International Monetary Fund warned Tuesday that the coronavirus pandemic is plunging the world economy into the deepest downturn since the Great Depression. Economists at JPMorgan Chase are now predicting US GDP could collapse by 40% during the second quarter and that the unemployment rate will spike to 20%.

Already, millions of Americans have lost their jobs and countless small business owners are desperate for loans to keep their firms alive.

‘I’m not confident’

Are banks ready for this storm?

“I’m not confident,” Bair said. “We don’t know how bad this will be and we don’t know how it will flow back to banks.”

Bank profits, which are used to pay out dividends, are already shrinking.

“I support dividends in good times but in times like this, banks have a special role in supporting the economy and should be retaining capital,” Bair said.

But the Federal Reserve is not on board with forcing banks to touch their dividends — at least not yet.

Powell added, however, that the Fed will be “watching to see how things evolve.”

ECB asked banks to delay dividend payouts

There are key differences between European and American lenders.

First, US banks entered this crisis in a stronger position than their European peers because of regulatory changes made after 2008. European lenders were also saddled with weak growth and negative interest rates, both of which hurt earnings.

“Banks have stood as highly capitalized sources of strength to the economy during this crisis,” said Sean Oblack, a spokesman for the Bank Policy Institute, a lobbying group that represents US banks.

European banks pay dividends only once a year, typically in the spring, while US bank dividends are distributed quarterly. That gives US regulators more leeway to require changes if the downturn lasts longer than anticipated.

US banks return the vast majority of their capital through share buybacks rather than dividends. And buybacks were already turned off a month ago.

“That’s a good thing,” Powell said of the buyback suspension.

The Fed wants to be careful not to make any moves that suggest a lack of faith in the system.

“If regulators somewhat immediately called on banks to cut or cancel dividends, it would cause more concern from a confidence level than it would have a beneficial impact on retaining capital,” said Ed Mills, Washington policy analyst at Raymond James.

So if the Fed wants to take action on dividends, it could do so in coming months as it reviews banks’ 2020 capital plans for shareholder payouts. Details are scheduled to be released at the end of June.

Shape of the recovery will dictate dividends

Some believe it would be prudent for banks to cut dividends now to preempt political pressure to do so.

“This would be a smart political move, as banks would show that they are capable of cutting dividends when conditions worsen,” Jaret Seiberg, analyst at Cowen Washington Research Group, wrote in a note to clients last week.

For now, big banks are voicing confidence in their ability to keep dividends intact, despite shrinking profits.

“We currently also have capacity and intend to continue to pay” the dividend, Jennifer Piepszak, JPMorgan’s chief financial officer, told analysts during a conference call Tuesday.

Wells Fargo CEO Charlie Scharf said his bank’s dividend payouts “make sense” because the company has tested its ability to return capital — even in “these severely stressed environments.”

However, Scharf acknowledged Wells Fargo can’t foresee the future.

“Ultimately the timing and the pace of recovery is going to determine earnings capacity for everyone to be able to continue to support the level of dividends,” Scharf said.