Tests produce winners and losers. The one that the government imposed on the nation’s biggest banks this week was no exception.
The Federal Reserve on Thursday released results of its annual stress tests, which assess whether large banks have enough capital to make it through an economic crisis, and whether they have the systems and plans in place to deal with the related upheaval. When banks fail the tests, the Fed may limit how much money they can pay out to shareholders or, in the case of the U.S. operations of foreign banks, how much they can pay to their parent companies.
The Fed last week said that all of the 35 banks it tested had sufficient capital to absorb the losses that might occur in the hypothetical crisis. Because banks are earning big profits right now, the first round of stress tests raised hopes that banks would be allowed to pay out most of those profits to shareholders when the test turned on Thursday to their operational capabilities.
The Fed only objected to the capital payouts of a U.S. entity belonging to Germany’s Deutsche Bank, which includes its large Wall Street operations. Goldman Sachs and Morgan Stanley did not fail on Thursday, but their pass came with restrictions.
Here, DealBook takes a closer look at how the tests played out.
Who were the clear winners?
The public: The ultimate reason the Fed is testing the banks is to make sure they can keep lending through a financial crisis and not require bailouts. The stress tests have not always existed. They were introduced after the financial crisis of 2008, and most experts agree that they’ve made the big banks safer. The most common way of measuring a bank’s strength is to look at its capital levels. As the Fed noted on Thursday, the 35 banks in the stress test had more than US$1.2-trillion of capital at the end of 2017, an increase of approximately US$800-billion since 2009.
A caveat, though: The tests may get tweaked in the future in ways that make them easier for the big banks. In proposed changes to the stress tests and capital requirements, the Fed has suggested removing a measure of capital, known as the supplementary leverage ratio, that some banks find hard to meet. “This will make the stress tests less stressful,” said Gregg Gelzinis, of the left-leaning Center for American Progress.
Wells Fargo is a surprising winner: The bank has been embroiled in several scandals that harmed customers. That did not appear to hold it back in the stress tests. Nor did the stringent regulatory action the Fed imposed on the bank earlier this year, which included a cap on its growth. Wells Fargo, having passed the stress tests, on Thursday announced that the Fed had signed off its plan to initiate roughly US$33-billion in stock buybacks and dividends, more than double the amount approved after last year’s test. That payout would be 40 percent more than earnings analysts expect Wells Fargo to make in the second half of this year and the first half of next, which is the period covered by the banks’ capital plans. One possible reason Wells Fargo can distribute so much capital is that it needs less to finance new loans since the Fed restrained its growth. The big payouts make the balance sheet cap imposed by the Fed less painful for the bank’s shareholders.
How bad was it for Morgan Stanley and Goldman Sachs?
The limit on payouts carries a stigma, but it could have been worse. Morgan Stanley’s planned US$6.8-billion distribution to shareholders after this year’s stress test is close to what it planned after last year’s. Goldman’s planned payout for this year, US$6.3-billion, is lower than last year’s request of about US$9.9-billion. But it’s important to note that Goldman has only paid out roughly US$5.7-billion of last year’s sum.
One reason the Fed did not object to the two firms’ capital plans is that, although their payouts would have taken their capital below minimum requirements in the stress tests, there were mitigating circumstances. The two banks’ results were negatively affected by the recent tax bill enacted by Congress. Adapting to the new law, which meant doing things like repatriating money from abroad, caused losses at Morgan Stanley and Goldman Sachs that depleted their capital going into the stress tests. Because of the one-time nature of the losses, and the fact that the tax cuts will bolster earnings over time, the Fed did not object to the two banks’ plans.
Even so, it appears that Morgan Stanley had to reduce its plan by about US$1.9-billion and Goldman Sachs by roughly US$1.2-billion, according to calculations by The New York Times.
Deutsche Bank is still in the doghouse
The giant German lender has had years to try and mend the problems affecting its U.S. businesses before they were subject to the Fed’s stress tests. But the Fed does not appear to be seeing sufficient improvement. On Thursday, it said it objected to the capital plan of Deutsche Bank’s U.S. entity, known as DB USA, because of “widespread and critical deficiencies across the firm’s capital planning practices.”
In a statement, Deutsche Bank on Thursday said DB USA had “made significant investments to improve its capital planning capabilities as well as controls and infrastructure.”