What happened

Do you love dividends? Do you like investing in bank stocks? Then today might be a bad one for you.

Shares of banks large and small -- from giants JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC) all the way down to smaller Huntington Bancshares (NASDAQ:HBAN), with its market capitalization of just $10 billion, are tumbling today. JPMorgan Chase is down 4.9%, Bank of America 5.3%, and Huntington 9%, all after the Board of Governors of the Federal Reserve System dropped a bombshell last night.

Closeup view of a Federal Reserve building with columns and blue-green ornamentation

Image source: Getty Images.

So what

So what did the Fed do to wreck banking stocks last night? After close of trading for the day, the Fed issued a press release containing the results of stress tests for 2020 and -- this is the important part -- "additional sensitivity analyses conducted in light of the coronavirus event."  

Here's the good news: "The banking system has been a source of strength during this crisis," said Fed vice chair Randal K. Quarles, "and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks."

But now here's the bad news: After finding America's big banks likely to remain healthy under most conditions, the Fed then proceeded to run a series of hypotheticals to test how banks would fare in the face of "a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession." These are "significantly more stringent" tests in which unemployment rates could climb to 15.6% or even 19.5%.

What it found was that most banks would "remain well capitalized" under such scenarios, "but several would approach minimum capital levels." In order to minimize risk, therefore, the Fed has ordered that "large banks ... preserve capital by suspending share repurchases, capping dividend payments, and allowing dividends according to a formula based on recent income. The Board is also requiring banks to reevaluate their longer-term capital plans."

Now what

And this, in a nutshell, is what happened to JPMorgan Chase, Bank of America, and Huntington Bancshares stocks today. The Fed has ordered flat out that "no share repurchases will be permitted" in the third quarter. The Fed is also "capping dividend payments to the amount paid in the second quarter," and may even require that dividends be reduced "to an amount based on recent earnings" if a given bank's earnings take a hit in Q3.

On the one hand, in the big picture, this is good news for the economy -- and perhaps even for banks -- because the Fed is going proactive to shore up the strength of the banking system before the economy can get any worse than it already is. On the other hand, the Fed has arguably removed a bastion of support from JPMorgan Chase, Bank of America, and Huntington Bancshares stocks, as none of these would be permitted to buy back shares should they begin to collapse in the face of a worsened recession in Q3.

It's also knocked the legs out from under any investors who were planning to hold these stocks in hopes of bigger dividend payouts. Put these two effects together, and it's no wonder investors are upset.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.