2017 Stress Tests: Bank of America Cleared to Increase Dividend and Share Buybacks

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The Federal Reserve announced the results from the second round of this year's stress tests on Wednesday, clearing Bank of America (NYSE: BAC) and 33 other large banks to raise their dividends and buy back more stock.

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Bank of America responded by doing just that, announcing that its board of directors has approved a 60% increase in its dividend. This is only the third time since the financial crisis that the nation's second biggest bank by assets has done so. Bank of America also said it will add $12 billion to its share repurchase authorization.

Metric

2017 CCAR

2016 CCAR

Dividend per share

 $0.12

$0.075

Stock buyback authority

$12 billion* 

$5 billion

Going into the stress tests, KBW projected that the Charlotte, North Carolina-based bank would raise its dividend by 33%, from a current quarterly payout of $0.075 per share up to $0.10 per share. Bank of America was also expected to increase its share buybacks this year by roughly $4.5 billion, or 64%.

The Dodd-Frank Act stress tests

Bank of America's success in the first round of this year's stress tests foreshadowed today's announcement. The results from the first round, referred to as the Dodd-Frank Act stress test, or DFAST, were published last Thursday. They revealed that Bank of America has far more capital than it would need to survive a hypothetical economic downturn akin in severity to the 2008 crisis.

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The controlling threshold in DFAST is a common equity tier 1 capital ratio, or CET1 ratio, of 4.5%. So long as a bank exceeds this through the test's nine-quarter time horizon, it passes. If it doesn't, then it fails.

In Bank of America's case, it wasn't even close. Going into the test, its CET1 ratio was 12.1%. While this dropped to 8.9% at the low point in this year's exercise, that still nearly doubled the regulatory minimum of 4.5%.

The Comprehensive Capital Analysis and Review

The second round of the stress tests, known as the Comprehensive Capital Analysis and Review, or CCAR, takes this exercise one step further. It gives the Fed veto power over big bank capital plans -- whether to raise their dividends, and how much stock to buy back.

As the Fed explains:

When considering a firm's capital plan, the Federal Reserve considers both quantitative and qualitative factors. Quantitative factors include a firm's projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm's capital planning process, which incorporate the risk management, internal controls, and governance practices that support the process. The Federal Reserve may object to a capital plan based on quantitative or qualitative concerns. If the Federal Reserve objects to a capital plan, a firm may not make any capital distribution unless expressly authorized by the Federal Reserve.

Bank of America has run into problems on the CCAR in the past. Its request to increase its dividend in 2011 was denied. And while it was allowed to raise its dividend in 2014, it waited a full year before requesting another increase, not doing so again until in 2016. Meanwhile, many of its peers have raised their quarterly payouts annually since 2010.

All told, Bank of America sailed through this year's CCAR. After factoring in its planned capital actions, its minimum CET1 ratio fell to 6.8%, still comfortably exceeding the 4.5% minimum.

Expectations that Bank of America would pass this year's CCAR, and thereby accelerate its capital return program, caused its shares to close 2.6% higher on Wednesday, adding another 1.3% in after-hours trading.

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John Maxfield owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.