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Fed Stress Tests Stress Bank Dividends (Update 1)

Updated with comments from FIG Partners analyst Christopher Marinac about SunTrust and Regions Financial.

NEW YORK ( TheStreet) -- Even the strongest among the large U.S. banks subject to the Federal Reserve's third round of stress tests will feature a severe set of economic assumptions that will likely put a damper on dividend increases for even the strongest of the big

The third round of stress tests will begin early next year, with the original group of 19 large U.S. banks -- including the "big four" of JPMorgan Chase (JPM - Get Report), Bank of America (BAC - Get Report), Citigroup (C - Get Report) and Wells Fargo (WFC - Get Report), as well as U.S. Bancorp (USB), PNC (PNC), Goldman Sachs (GS), Morgan Stanley (MS), and 11 other companies -- being joined by 12 more bank holding companies with over $50 billion in total assets, including Huntington Bancshares (HBAN), Discover Financial Services (DFS - Get Report) Northern Trust (NTRS), M&T Bank (MTB), Comerica (CMA), and Zions Bancorporation (ZION).
Banks execs planning dividends will feel sharp pains following Fed stress testing.

The banks subject to the stress tests are required to submit their detailed 2012 capital plans -- including any plans to increase a return of capital to investors through increased dividends or share buybacks -- by January 9, and will have their plans approved or rejected by the Federal Reserve by March 15.

According to FIG Partners analyst John Rodis, "the metrics for the tests this time around will be a lot more stringent" than they were for the second round of stress tests earlier this year:
  • Gross domestic product declining 4% vs. 1.5%.
  • Unemployment reaching 13%, vs. 11%.
  • Home prices falling 21% vs. 11%.
  • Equity markets declining 52% vs. 27%.

Now that's a brutal set of economic assumptions.

"The good news," according to KBW analyst Frederick Cannon, "is that most large banks have increased capital levels significantly during the last year."

On the other hand, Cannon expects the stress tests "limit capital deployment at the stronger banks," as well as pressure weaker banks, including Bank of America and Regions Financial (RF) -- which stands out among the largest publicly traded U.S. banks in owing $3.5 billion in federal bailout funds received in 2008 through the Troubled Assets Relief Program, or TARP -- into "more activities that improve capital ratios, but reduce earnings."

Cannon said that the Fed is being much more strict this time around in order to build credibility by taking the "contagion and risk to the U.S. banking system" from the European debt crisis into account, and making the U.S. tests "more credible than what is presented in Europe.
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