Fed stress tests: Deutsche Bank fails; Goldman Sachs and Morgan Stanley are limited on payments

Six banks were forced to cut back on their capital return plans, showing that a growing economy and stronger bank profits are encouraging leaders wanting to reward shareholders after the lean years. Other banks have been affected by the recent changes to the tax law and a worst-case scenario that has been the hardest in the eight years of the Fed's annual tests.

The first round of stress tests last week revealed that the 35 companies that were tested would survive a merger and be able to continue lending. On Thursday, regulators declared 34 of them – all except the US unit of the German lender in difficulty

German Bank
AG

DB 0.87%

– had capital planning processes that met the expectations of the Fed. In total, banks were allowed to pay 95% of their expected profits in the coming year, according to a senior Fed official.

Goldman and Morgan Stanley will not be able to increase their dividends or buybacks for the time being – the same consequence as facing the test. The Fed spared them the black eye of a poor rating in part because of the complexity of the 2017 tax law, which has reduced the value of some tax assets held by banks, according to senior officials from the Fed.

In the long run, however, banks are among the biggest beneficiaries of the new, lower corporate tax rate.

After Goldman and Morgan Stanley barely made a capital requirement in preliminary tests last week, the two banks told investors that the results were not necessarily representative of the capital that the Fed was giving them. would pay back.

State Street Inc. must take action on how it analyzes what would happen if its main trading partner went bankrupt, the Fed said.

The Fed said it expects Goldman, Morgan Stanley and State Street to reinforce their short-term capital positions. Companies can seek the approval of the Fed for additional payments before the stress tests next year.

JPMorgan Chase

& Co.,

American Express
Co.

,

KeyCorp

and

M & T Bank
Corp.

only after having reduced their payment requests following the results of the first round of tests last week.

The results "demonstrate that the largest banks have high capital levels, and after making their distributions of capital approved, would retain their ability to lend even in a severe recession," he said.

Randal Quarles,

Vice President of the Fed for Supervision

Now in its eighth year, the tests are aimed at giving the public, who has borne the costs of the last crash, the confidence that the banks are ready for the next one. Banks have been better off testing in recent years by raising capital, reducing their risky business and learning more about the Fed process. Last year, every bank was successful, a first since the Fed published its annual results in 2012.

This year's test has been the hardest to date, according to Fed officials and banks. unemployment figures, house and stock prices, and skyrocketing credit cards and auto loans.

The US unit of Deutsche Bank failed after the Fed found "material weaknesses" in its data and controls. This failure will limit the profits that the US unit can send to its German parent company.

One of Deutsche Bank's US subsidiaries has now failed the Fed's tests in three of the past four years. That was the Fed's latest reprimand, which last year had seen its US operations downgraded to the Fed's "troubled condition," the Wall Street Journal reports. JPMorgan, American Express, KeyCorp and M & T both passed after a "mulligan", ie again presenting a more conservative return-capital plan after obtaining their first-round test results last week.

In the years following the crisis, the banks only distributed a fraction of their profits to the shareholders, storing the rest to build their capital reserves absorbing the losses.

In 2013, the average bank paid about 60% of revenue, according to Autonomous Research. This ratio has been approaching 100% in recent years, reflecting a steady state of earnings-in-profits-out.

The increase of dividends and buybacks of juice and the improvement of parameters such as the total return to shareholders, which often reflects the amount of salaries paid to senior executives

at 39 In the future, shareholders may have less to, who are looking for a growing economy and the prospect of a decline in regulation and who wish to reinvest their profits in the company.

Goldman suspended its buyback program in the second quarter of this year to fund new initiatives. . The company was allowed to pay up to $ 8.7 billion in last year's stress tests and plans to return between $ 5 billion and $ 6 billion.

The Bank's shares are also close to their historical highs, relative to earnings, so redemption dollars do not go that far. "There is a price at which you will not buy back shares," said the CEO of JPMorgan.

James Dimon

said last month. "The ideal – and I think we'll come back to someday – is that you use your excess capital to grow."

Wells Fargo

approved its return on investment plan, challenging some industry watchers who expected the Fed to use stress tests to express its dissatisfaction with a scandal at the San Francisco-based bank.

The Fed can reject banks' plans for "qualitative" reasons. In February, Wells Fargo decided to ban the expansion of its assets until the bank attacks "widespread consumer abuse and compliance failures."

Wells Fargo said it was carrying about $ 25 billion of capital approval from the Fed, to return to shareholders over the next few years. "We are optimistic about the result of [test]"

Timothy Sloan

told investors last month. "That said, it's out of our control."

Regulators relax stress tests for small regional lenders. Most banks with less than $ 250 billion of assets can no longer fail for qualitative reasons, and three companies with less than $ 100 billion of assets …

CIT Group
Inc.,

Comerica
Inc.

and Utah-based Zions Bancorp were fully exempted this year.

In April, the Fed proposed replacing the tests of an exercise of success and failure with a more forward-looking exercise tailored to each company. Based on the performance of a bank in the simulated crash, he would be given a minimum capital ratio to achieve. Under this system, the banks' capital yields could still be restricted, but they would not face the same public reprimand from the Fed.

Write to Liz Hoffman at [email protected] and Lalita Clozel at lalita.clozel. @ Wsj.com