JEROME Powell is putting big United States banks through two stress tests.
The Federal Reserve (Fed) chair's merciless interest-rate increases are hitting asset values hard, and that's likely to prove painful in second-quarter earnings and beyond.
Share buybacks by most big banks are already slower this year than last as they cope with billions of losses on government bonds they own and potentially on debt deals underwritten for clients.
Meanwhile, the just-published results of the Fed's theoretical crisis exams showed big banks have plenty of capital to survive a severe shock.
It ran tougher scenarios than last year, including a bigger rise in unemployment and drop in home prices.
At the same time, the Fed has already told JPMorgan Chase & Co, Citigroup Inc and Goldman Sachs Group Inc to build in bigger cushions next year to guard against the systemic risks they present.
And yet for shareholders, the news is that dividends and buybacks in 2023 will still likely be extremely healthy.
In forecasts made ahead of the Fed's stress test result, JPMorgan was expected to lead the pack with dividends and buybacks in 2023 adding up to US$19bil (RM84bil) to US$21bil (RM92bil), according to estimates from analysts at Barclays and Jefferies.
That is way down from 2021's total of nearly US$30bil (RM132bil), but that included profits held over from 2020 during the depth of the Covid crisis.
Bank of America Corp (BofA) and Wells Fargo & Co are next in line, both forecast by Barclays to return a total of more than US$15bil (RM66bil) and by Jefferies to return nearly US$21bil (RM92bil), again much lower than last year.
Morgan Stanley follows, then Citigroup, and Goldman brings up the rear with estimated payouts of US$6bil (RM26bil) (Barclays) to nearly US$8bil (RM35bil) (Jefferies).
The banks can start outlining their capital plans next week.
Next year's buybacks are likely to be better than this year's, especially for the big deposit taking commercial banks.
JPMorgan has already slowed share repurchases this year in part because of declining values of Treasuries held on its books as interest rates rose.
Executives at BofA, Wells and Citi made cautious comments about stock repurchases during first-quarter earnings calls.
All four suffered billions in unrealised losses in the first three months of the year and are likely to do so again because of further Fed rate increases.
Very short-term Treasury yields and very long-term ones have risen more in the second quarter than in the first.
However, yields between two and seven years have risen less.
This should mean losses for banks are less bad, according to Mike Mayo, an analyst at Wells Fargo.
Mayo says moves in five-year yields are the best indicator.
They could still amount to 2.5% to 3.5% of equity, he estimates.
For investment banks, there could also be big losses on debt they have underwritten for companies.
This is especially true for those involved in buyout deals, as investor appetite has dried up.
Some loans and bonds are being sold at heavy discounts as Wall Street looks to clear risky deals off the books.
The saving grace for some will be strong profits from active trading in currencies, rates and commodity-linked products.
Citigroup, for example, expects trading revenue to be up 25% this quarter compared with results in the period a year earlier.
Sharply rising interest rates to fight inflation underpin all of this and should lift revenue for commercial banks through higher net interest income even as they initially roil markets.
Still, shares in all these banks except Wells have underperformed the S&P 500 Index.
This goes to show that investors are ignoring the lower risks and greater resilience of banks, Mayo said.
The volatility in banks' capital returns in recent years and the fact that regulators acted to restrict payouts during the Covid pandemic in 2020 raise questions about the point of the stress tests.
They are meant to prepare banks for the worst so that they can keep making their own decisions on capital when disaster strikes.
Critics of the Fed's tests, meanwhile, say they have been so watered down under the loosening of rules by President Donald Trump's administration that they are ineffective.
The truth is in between: The tests are important for banks and regulators to exchange information.
Further, they help set bank capital requirements tailored to the real risk they present in a reasonably transparent way.
Bank executives will almost always argue they have too much equity.
However, shareholders are still reaping handsome rewards.
The lessons of previous crises are that regulators are right to err on the side of caution. — Bloomberg
Paul J Davies writes for Bloomberg. The views expressed here are the writer's own.
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