Bank of America Corp‘s (BAC) plan to boost its dividend in the second half of 2011 was rejected by the Federal Reserve, as per a company filing on Wednesday. This comes as a rude shock to BofA, particularly after many big banks got the much-awaited green signal from Fed to hike dividends, following the release of stress test results last week.
The Fed allowed America’s strongest banks that passed the second round of stress tests to operate independently and freed them of government restrictions imposed during the height of the financial crisis in 2008. But the story was different for BofA. The largest U.S. bank by assets needs to show the Fed even more financial strength, lest it needs to combat another financial crisis. The Fed wants BofA to be at least as strong as its rivals that got the approval to deploy capital.
Though jilted, this is not the end of the line for BofA. The Fed has given the company another chance to submit a revised capital plan for its consideration. BofA has said that it will resubmit its plan, requesting the central bank to allow a modest dividend increase in the second-half of the year.
In January, all 19 banks subjected to the stress tests in 2009, had submitted their capital plans to the Fed. These banks were required to demonstrate that they have adequate capital to address potential losses over the next two years under various scenarios.
The second round of stress tests was basically a precautionary exercise amid the economic recovery. Also, as the banking industry swung back to profitability in 2010, big banks began pressing regulators to allow them to enhance shareholder value through dividends and buybacks.
Though the Fed allowed some banks to increase dividends, the payments will be restricted to up to 30% of a bank’s expected earnings for 2011. This is obviously far below the approximately 50% paid prior to the crisis.
However, the 30% threshold is still good. Most importantly, the increase is an indication of economic improvement. Resuming dividend increase from the quantum drop will definitely help these banks access capital over the long term.
Though BofA and Citigroup Inc. (C), the biggest recipients of the bailout money during the height of the financial crisis, cleared off their dues, they did not announce any dividend increase immediately due to their fundamental weakness compared to rivals.
However, earlier this week, Citigroup said that it will reinstate a 1 penny per share quarterly dividend. It has also announced a reverse stock split. On the other hand, despite planning a very small dividend increase, BofA did not get the clearance from Fed.
This is definitely a bad event for BofA. The rejection of the dividend plan by the Fed will surely affect investor’s confidence in the stock. Tough times befall the company, as it must first strengthen its capital position. Until BofA achieves a stable financial state, regulators will continue with their cautious approach.
This is not the final round. The big banks will have to face the Fed’s stress test once every year. The primary intention is to keep a regular check on a bank’s financial strength to deal with another financial crisis.
Currently, BofA retains a Zacks #4 Rank, which translates into a short-term Sell rating. However, considering the fundamentals, we are maintaining a long-term Neutral recommendation on the stock.
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