The Federal Reserve could tell major U.S. banks as soon as next week whether regulators' stress tests show they're healthy enough to boost stock dividends.
Banks have been eager to reduce massive capital cushions they built up as they recover from the 2007-2009 financial crisis, but regulators have been nervous to let them chip away at these reserves.
The Federal Reserve's most recent stress tests, which apply to the 19 largest U.S. bank holding companies, are wrapping up as European regulators are doing their own fresh battery of tests. Last year's European stress tests were widely criticized for a lack of transparency and credibility.
Banks and analysts are viewing a Fed decision to allow banks to boost payments to shareholders as a signal to markets the financial crisis is behind the industry.
"Let's get this mark of Cain off the banks," said Nancy Bush, an analyst with NAB Research.
Among the banks analysts said are most likely to be given the green light to boost dividends or buy back shares are US Bancorp, Wells Fargo, JPMorgan Chase and PNC Financial Services Group Inc.
The bank holding companies being stress-tested are the same group of firms the Fed tested in early 2009, in an exercise designed to shore up market confidence in those firms' balance sheets.
Analysts said the chances that the Fed will allow no banks to boost their dividend are low.
"If the healthiest of the healthy banks are not allowed to pay a dividend at this point in time, then what is that saying about the Fed and the Treasury's view of the overall economic environment? Not very good," said Christopher Mutascio, an analyst at Stifel Nicolaus & Co.
Most of the largest U.S. banks are targeting a dividend increase in 2011 or 2012 to roughly 30 percent of earnings.
The 30 percent target is below the 50 percent threshold many banks paid out during the boom years. But investors are clamoring for a return to more normal payments after dividends were slashed to a penny a share, or eliminated entirely during the financial crisis.
ROAD TO RECOVERY
Banks not seeking permission for an increase are still required to submit capital plans as part of the Fed effort to regularly test the health of the 19 biggest institutions.
The Fed will not release results of its testing for individual banks and exactly what it will say publicly is unclear. It will be up to the banks to announce whether they have permission to increase their dividends.
The test results come as U.S. banks are showing signs of a sustained recovery. According to FDIC data, about 68 percent of U.S. banks showed year-over-year earnings growth in 2010 -- the largest percentage since 2002.
In total, U.S. banks earned $87.5 billion in 2010. While still well below the peak earnings of $145 billion in 2006, the profit reverses a $10 billion loss in 2009.
There remain concerns, however, because profits have gone up mostly due to banks setting aside less to guard against bad loans and other losses, as opposed to raising revenue from lending.
Some Democratic members of Congress wrote the Fed last month questioning why dividends should go up while some banks still benefit from government support through the Temporary Liquidity Guarantee Program set up in the crisis and while they still face problems in the housing market.
The Fed has so far been hesitant to let banks increase dividends, knowing it will be hard to ask them to scale back later.
Under the Fed's test, banks will have to show they can absorb losses over the next two years under situations where there are broad economic problems and problems specific to a firm's business model.
They will also have to show that they can already meet the new international capital standards in the Basel III agreement. The Basel rules are being phased in over several years from 2013 to roughly triple to 7 percent the minimum core capital a bank must hold to withstand shocks and leave taxpayers off the hook in the next crisis.
The Fed said banks would be expected to repay any government funding they received before boosting dividends.
KeyCorp, Regions Financial Corp and SunTrust Banks Inc have not repaid taxpayer funds.
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