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

America’s big banks paid out fat dividends to shareholders during the Great Recession, leaving them with less capital to absorb massive losses.

Now,big banks face another economic catastrophe, and this time some players involved in the last crisis are urging regulators to force lenders to preserve cash by suspending dividend payouts.

“Every dollar of capital that goes to shareholders is a dollar not there to absorb losses and support their lending. Keep it!” Sheila Bair, who led the FDIC during the 2008 crisis, told CNN Business.

The nation’s eight biggest banks, seeking to get ahead of political pressure to lend to Americans hurt by the coronavirus pandemic, announced in mid-March they would all halt their generous share buyback programs. But that stillmay not be enough.

Former Federal Reserve Chair Janet Yellen thinks America’s banks need to halt dividends, too, because of the vast uncertainty facing the country.

“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.”

America’s four largest banks, JPMorgan Chase, Bank of America (BAC), Citigroup (C) and Wells Fargo, paid out more than $29 billion in combined dividends in 2019, according to filings.

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 shockisone that few saw coming.

Related article JPMorgan's profit plummets 69% because of coronavirus

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.

That economic turmoil will deal a significant blow to banks, sapping demand for mortgages and causing existing loans to go bust.

‘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.

JPMorgan (JPM), the nation’s largest bank, on Tuesday reported a 69% plunge in first-quarter earnings because it set aside a stunning $6.8 billion of reserves to cushion against loan defaults. Wells Fargo’s (WFC) profit plummeted 89% as the bank’s provision for credit losses quadrupled to nearly $4 billion.

“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.

“I don’t think that’s something that needs to be done at this point,” Fed chief Jerome Powell said last week during a Brookings Institution webinar. “I think our banks are highly capitalized, far more highly capitalized, with more high-quality capital than they were before the financial crisis.”

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

ECB asked banks to delay dividend payouts

European banks aren’t waiting.

UK banks such as HSBC (HBCYF), Standard Chartered (SCBFF) and Lloyds (LLDTF) halted their dividend payments at the request of regulators. The European Central Bank likewise asked banks not to pay dividends until at least October.

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.

Customer, some wearing face masks, line up outside a Wells Fargo branch in the Atwater Village neighborhood of Los Angeles on Friday, April 3, 2020, during the coronavirus outbreak. (AP Photo/Damian Dovarganes)

Related article Fed (temporarily) takes the shackles off Wells Fargo, freeing it to help small businesses

European banks pay dividends only once a year, typically in the spring, whileUS 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.