U.S. regulators gave major banks including JPMorgan Chase & Co the green light on Friday to boost dividends, loosening the reins on the industry 2-1/2 years after the government bailed out the financial system.
The strongest banks, including JPMorgan, are entitled to raise dividends and buy back shares in a matter of weeks, while weaker banks, including SunTrust Banks Inc, were authorized to issue shares and pay back government bailout money.
The Federal Reserve tested how banks would fare if the economy were to come under more pressure, in another round of stress tests nearly two years after the first round. European banks face similar tests.
Banks received billions of dollars of rescue funds from the government in 2008 and 2009 after suffering huge losses in a credit crunch. But in 2010 the banking system turned a profit, emboldening regulators to permit banks to return money to shareholders through dividends and buybacks.
This is one of the final steps in terms of showing the redemption of the banks from 2008, said Matt McCormick, a portfolio manager at Cincinnati-based Bahl & Gaynor Investment Counsel, which owns bank stocks.
Banks are still recovering from the financial crisis, and the Federal Reserve has still kept some restrictions on their payouts to shareholders.
The central bank said on Friday it was generally restricting dividend payments to 30 percent or less of the company's expected earnings in 2011-- a ratio well below the 50 percent level paid out during better times.
But a flurry of banks announced plans to return capital to shareholders on Friday. Wells Fargo & Co, the fourth-largest bank, said it was paying a 12 cent per share dividend for the first quarter, compared with a prior level of 5 cents.
Goldman Sachs Group Inc said it was buying back $5 billion of preferred shares from Warren Buffett's Berkshire Hathaway, ending a costly deal that shored up confidence in the bank at the height of the financial crisis.
Buying back the preferred stock will allow it to boost the dividend on its common shares, Goldman said.
This gets the banks some investor credibility. If you're a retail investor, the reason to own these names was the dividend stream, and that was taken away with the crisis, said Jason Ware, a senior analyst with Albion Financial, a Salt Lake City-based wealth management firm.
Albion currently does not own any bank stocks, but Ware said the dividend increases have made the firm more interested in buying into the sector.
In this second round of stress tests, the Fed had banks submit their own analyses of whether they could withstand adverse economic conditions. In 2009, the Fed played a much larger role in analyzing banks' capital.
Banks historically have paid dividends, but often have trouble cutting their payouts when times get tough, for fear of panicking investors. In the years leading up to the crisis, banks paid out billions of dollars to investors, through dividends and share buybacks, even as the financial system grew shaky.
The stress tests are not over. Under the Dodd-Frank law tightening regulation of the financial industry, large banks and other financial firms are required to conduct stress tests at least once a year.
Three of the 19 largest banks have yet to repay the U.S. bailout aid they took at the height of the financial crisis.
But investors hailed plans by two of the three, SunTrust Banks Inc and Keycorp, to do so as another sign of the industry's recovery.
That's very good, said Marshall Front, chairman and chief investment officer at Front Barnett Associates in Chicago, who owns bank stocks.
It can't be viewed as anything but positive for them, and reflects trends for the banking sector in general, he said.
Regions Financial Corp, the last remaining TARP holdout in the group of 19, said the company did not propose any capital action in its regulatory review, and will repay TARP in a prudent manner, on shareholder-friendly terms.
Investors have been eager for banks to restore quarterly payouts after they were suspended or slashed to as little as a penny a share at the height of the 2007-2009 financial crisis.
According to the Fed, common equity increased by more than $300 billion at the big banks from the end of 2008 through 2010. (Reporting by Rachelle Younglai in Washington, Maria Aspan in New York; additional reporting by Joe Rauch in Charlotte; Editing by Gary Hill)