All 18 banks reviewed passed round two of the Federal Reserve’s stress tests, an annual exercise designed to gauge banks’ ability to withstand a recession. It was only the second time since the Fed began administering the exams that no bank failed.
A few banks in regulatory hot water were cleared, opening the door for a wave of dividends and stock buybacks that could boost bank stocks left behind in the market rally. This year’s scenario was among the toughest yet, but a recent Fed overhaul of the test made it easier for banks to pass.
Banks have gotten better at taking the test, now in its ninth year, amassing enough capital and know-how to maximize shareholder payouts without failing, Fed officials said. The 18 banks, a group that includes giant U.S. lenders JPMorgan Chase & Co. and Bank of America Corp. , are expected, in aggregate, to increase their payouts to more than 100% of expected earnings.
“The results show that these firms and our financial system are resilient in normal times and under stress,” said Randal K. Quarles, the Fed’s vice chairman for supervision.
The two-stage process, introduced by the Dodd-Frank financial overhaul, first measures how the banks would fare in severe economic scenarios, including double-digit unemployment and a 50% decline in U.S. stocks. Those results, released last week, showed an industry losing a total of $410 billion but left with more capital than in the prior year’s test.
For the second stage, the Fed measures how banks would fare under the same scenarios after increasing their dividends and stock buybacks. The outcome determines how much banks can return to investors and how much they have to keep socked away.
While no banks failed the second round of the test, JPMorgan and Capital One Financial Corp. had to resubmit their capital-return plans to stay above the Fed’s regulatory minimum capital levels. The Fed dinged Credit Suisse Group AG over its projections for trading losses in the test and gave it four months to improve its capital-planning processes.
JPMorgan’s ask was far more aggressive than expected. The bank was approved to boost share buybacks by $9 billion to $29.4 billion. Analysts had largely expected buybacks to remain flat. The bank also won approval to increase its quarterly dividend to 90 cents per share, up from 80 cents, in line with expectations.
Under its revised plan, Capital One boosted its buybacks to $2.2 billion from $1.2 billion and held its divided at 40 cents a share. The bank has higher credit-card loan losses than its peers.
Under a process known as the mulligan, banks are allowed to adjust their capital-return plans and retake the test if their initial proposals would put them below the line. Banks can be more or less aggressive under that process, giving themselves a capital cushion to stay well above the thresholds or cutting it close to pay out more to shareholders.
Wells Fargo & Co., which is operating under an unprecedented growth cap imposed by the Federal Reserve following a string of scandals, passed with a wide capital cushion.
Deutsche Bank AG , which failed the test last year and was told to improve its forecasting and risk controls, also was cleared this year. The bank’s U.S. operations have been under heightened scrutiny since the Fed in early 2017 downgraded the operations to “troubled condition” status, The Wall Street Journal previously reported.
Last year, the Fed allowed Morgan Stanley and Goldman Sachs Group Inc. to freeze their capital payouts at recent levels and obtain a “conditional non-objection” despite failing to clear regulatory requirements under the doomsday scenario. As a result, the banks avoided the black eye of failure without having to drastically cut shareholder payouts.
Both banks sailed through the tests this year. Goldman was cleared to return $8.8 billion to shareholders over the next year, up from $6.3 billion, including its biggest-ever dividend boost to $1.25 from 85 cents. Morgan Stanley can return $8.2 billion to shareholders in dividends and buybacks over the next year, up from $6.8 billion.
The results of this year’s stress tests could boost bank stocks, which have trailed the broader market this year on persistent concerns about the direction of interest rates and the possibility of an economic slowdown.
The steady pace of rate increases in recent years has allowed banks to charge more on loans while more slowly raising the interest they pay to depositors. The KBW Bank Index is up 12% this year, compared with a 16.7% gain in the S&P 500.
Seventeen banks skipped this year’s exercise under a new biennial schedule. Most of the 18 firms undergoing the test this year weren’t subject to a potential failure under the qualitative review, which evaluates a firm’s capital-planning analysis and internal controls.
Deutsche Bank, Credit Suisse and other foreign banks remained subject to potential failure because they were newer to the test.
The chance for a public shaming under the stress tests could soon recede even further. The Fed last year proposed eliminating the threat of failure for big banks on the numbers-based portion of the test, integrating their results instead into a continuous capital requirement.
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