NEW YORK--(BUSINESS WIRE)--Amendments to the Comprehensive Capital Analysis and Review (CCAR) rules will result in a broader and clearer application of limits on capital distributions for companies that submit their capital plans and stress tests to the Federal Reserve, according to Fitch Ratings. The Fed is also proposing changes in the timing of the CCAR process that may reduce the burden on subject banks.
The Fed's proposals announced on June 12 aim to close loopholes in CCAR and should instill even greater capital management discipline across CCAR banks, a credit positive. The revisions, however, could pose a challenge for some banks in maintaining dividend stability due to the Fed's wider scope of limitations to be judged on and applied to more forms of capital issuances and distributions, including sub debt, preferred and common, as well as dividends.
By broadening distribution curtailments to potentially include dividends could lead some banks to plan distribution buffers, such as budgeted share repurchases, which would later be curbed to protect dividend streams. Any propensity for banks to budget higher volumes of share repurchases could ultimately neutralize any positive credit impact.
Under present CCAR rules, it has been the Fed's practice to "approve repurchases of common stock on both a net and gross basis so that a company is required to reduce repurchases to the extent that the bank does not issue as much common stock as it had planned." The Fed's focus on limiting share repurchases based in part on just common issuance provided some banks the latitude for wide variations of issuance and distribution outcomes across other forms of bank capital. In prior CCARs, the Fed noted that banks could budget Tier I, additional Tier I, and/or Tier 2 capital raises, but not follow through on such issues, leading to share repurchase approvals that would be partly based on capital that was never raised.
In one of several examples provided in the Fed's proposals, a bank holding company (BHC) may budget the issuance of $50 million in common stock, dividends on common stock of $50 million, and a preferred stock repurchase of $50 million. If the BHC only executes $25 million of its planned $50 million of common issuance for that quarter, the proposed rule would require the bank to offset its common dividend by $25 million.
The BHC would not be allowed to offset the reduction in common stock issuances with a reduction in preferred stock repurchase or even by issuing new preferred stock because common stock has a greater capacity to absorb losses than preferred stock.
Thus capital distribution limits are proposed to be set such that if a company raises less than the amount that the BHC projected in any given quarter under its baseline scenario, then any plans for distributions on instruments with greater or equal loss absorbing ability would need to be curbed.
Fitch believes that this secondary impact could be seen as a threat to dividend stability and banks will feel elevated pressure to exercise even more caution on capital plans.
A further challenge with such a bank response, however, is that the Fed's proposals also seek to limit the practice of banks markedly changing distribution plans from one year to the next. The Fed indicated that "widely varying planned capital distributions... may be indicative of shortcomings in a BHC's capital planning processes." Such indications may lead the Fed to object to a bank's capital plan.
The Fed's proposed changes also would move forward the nine quarter cycle period, presently beginning on October 1, to January 1 of the following calendar year. This change should alleviate some of the burden placed on banks near year ends, when other financial reporting requirements constrain resources. The effective date of the change would be Jan. 1, 2016. The Fed's proposed amendments were released last Thursday and are open for a two month comment period ending August 11.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.