Stress test results signal more flexible new-look Fed

WASHINGTON (Reuters) – This year's Federal Reserve stress test results suggest a more flexible approach, a new directive that is responding positively to a Wall Street push for pragmatic bank supervision, analysts and lawyers said.

Banks that took a one-off capital hit due to the 2017 US tax overhaul got a conditional pass Fed's traditional strict pass-through approach to quantitative capital issues, while Scandal-plagued Wells Fargo & Co was able to double share buyback plans.

Goldman Sachs and Morgan Stanley have been dinged since their capital fell under the Fed's minimum, but the regulator's response to this year is under way. Chairman Jerome Powell and Vice Chairman Randal Quarles, Chairman Donald Trump appointees, analysts and lawyers said.

"They have been allowed to do business in the past, and they have had special circumstances and applied them to a level of pragmatism. This is the new Fed and it signals to me an early retirement of this super-strict quantitative test, "said Mike Alix, financial services risk leader at PwC.

The Fed on Thursday approved the capital plans of 34 following the second leg of its annual tests, a process introduced after the 2007-2009 financial crisis to assess banks' ability to withstand a severe recession. The U.S. central bank has ramped up its worst-case scenarios each year.

The U.S. tax code rewrite signed into law in December by Goldman and Morgan Stanley's Thursday results were weighed, in part, by changes to the treatment of past losses on hypothetical tax bills under the Fed's scenarios.

But since the tax issue was one-off and capital levels in the system are high, the Fed felt it was unnecessary to fail the two banks, senior Fed officials said.

Under the conditional approvals for their capital plans, the two banks may pay out capital distributions but must keep them in line with previous years.

Some analysts pointed to the Fed's conditional approval of State Street Corp.'s higher dividend even though its counterparty exposures showed high losses under the scenarios.

"This strengths the Federal Reserve was less draconian in how it reacted to the results," said Cowen's Washington Research Group's Jaret Seiberg in a note.

Wells Fargo won approval for the highest payout ratio of the major U.S. banks, which would have been part of the test measuring operational controls.

A passing grade could signal clearing skies ahead for Wells Fargo and better relations with regulators, according to analysts at Evercore Group LLC.

Democratic U.S. Senator Sherrod Brown on Thursday criticized bank payouts to "wealthy shareholders" and warned the Fed against easing up on how it approaches the tests.

BUFFER STRESS

Lenders have long complained the stress-test process is too opaque and that the Fed has been too harsh on the results of the Fed keeps secret.

Despite noting the Fed's pragmatic stance on Morgan Goldman Sachs and Morgan Stanley, industry insiders still questioned whether the regulator should have proceeded with the tough scenarios this year given the short-term adverse changes, and said they want further changes to make the process more transparent.

Powell and Quarles said they believe stress-testing can be more transparent and less discretionary, but banks continue to worry that Fed-easing may not go far enough or could inadvertently make life tougher if changes are not finely tuned.

They point, for example, to the Fed's April proposal to introduce a "stress capital buffer" that would work in tandem with the stress tests to move the system away from a strict quantitative quantitative pass-fail.

The Clearing House warned that they would actually exacerbate their capital planning challenges by demanding banks to capitalize themselves against year-round year-round stress.

"This year's results that are essential in the United States are highly volatile, but the volatility will be magnified by the stress buffer," they added.