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Fed Stress Tests Force 6 U.S. Banks to Scale Back Dividends

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Federal Reserve building in Washington. (Photo: AP) (Photo: AP)

Tougher Federal Reserve stress tests forced six U.S. banks including JPMorgan Chase & Co. to scale back proposals for doling out more cash to shareholders. Two — Goldman Sachs Group Inc. and Morgan Stanley  agreed to freeze total payouts at previous years’ levels.

American Express Co., M&T Bank Corp. and Keycorp also had to temper initial requests to distribute cash, according to results posted Thursday. Twenty-eight other firms can proceed with their original proposals to boost stock buybacks and dividends after the Fed found they’d still hold enough capital to weather a hypothetical economic shock. The regulator failed a U.S. subsidiary of Deutsche Bank AG, citing “widespread and critical deficiencies” in its planning, limiting the unit’s ability to send capital home to Germany.

Big banks may still be able to deliver the $170 billion in combined payouts that Wall Street analysts had predicted for the coming 12 months — about $30 billion more than in the previous four quarters. On average, firms will distribute about 95 percent of their profits, the Fed said, in line with analysts’ estimates.

And not every hiccup was a major surprise: While JPMorgan was expected to dramatically boost distributions, several analysts predicted Morgan Stanley would increase its payout only slightly, and that Goldman Sachs would return less cash. In the end, Morgan Stanley and Goldman pledged to keep their payouts at the previous year’s level, according to the Fed. JPMorgan said it will boost its quarterly dividend by 43 percent and buy back as much as $20.7 billion in shares.

Many banks subject to the test began disclosing their plans after results were posted. Wells Fargo & Co. said it will repurchase up to $24.5 billion of stock and boost its quarterly dividend by 4 cents a share. AmEx said it will buy back as much as $3.4 billion and increase its dividend 11 percent.

JPMorgan climbed 2 percent in late trading as of 4:55 p.m. in New York. Wells Fargo gained 3.3 percent while AmEx rose 0.7 percent.

The six lenders that eked through took what’s become known as a mulligan, lowering their initial proposals for distributing capital. Shareholders at Goldman and Morgan Stanley got hints of trouble last week, when the pair barely passed the test’s first round, which is based on continuing past payout levels. Their performance in that phase prompted both firms to race out statements, urging investors not to underestimate the firms’ ability to make payouts.

Goldman Sachs has already used the mulligan twice since 2013, when the option was introduced. Morgan Stanley used it once. It provides an advantage, letting the firms figure out the maximum they can pay.

This time, even their resubmitted plans were projected to leave them short of regulatory minimums in a severe crisis, the Fed said. The regulator said that in allowing them to pass, it considered that they had to book one-time charges in the fourth quarter linked to U.S. tax cuts — which will boost future earnings.

The Fed’s hypothetical scenarios were much harsher this year, including a 65 percent drop in stock prices, which created bigger theoretical losses for firms that have large capital markets businesses. Goldman and Morgan Stanley’s earnings rely more on trading and wealth management than bigger rivals who also do consumer and commercial banking.

“The stress scenario’s hits to capital ratios released last week were bigger than what we’d expected, especially for the universal banks,” Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods, said before Thursday’s results. “That probably caught the banks by surprise too.”

It’s the second year in a row that AmEx took the mulligan. The Fed also said State Street Corp.’s capital plan was approved on the condition that it improves its methodology on calculating counterparty exposures under stressed scenarios. State Street’s leverage ratio fell very close to the minimum in last week’s results, prompting some analysts to suspect it might curtail payouts. The custody bank didn’t have to revise its original request.

The Fed proposed major revisions to its exam program in April, which will probably be finalized later this year and go into effect with next year’s test. Banks will no longer fail the quantitative portion, and the hypothetical drop in their capital levels under stress will become a conservation buffer that will be incorporated into their ongoing minimum capital requirements. They can still fail the qualitative portion, which only 18 of the 35 firms being tested are subject to.


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