Despite US Fed’s stress tests, investors still get record payouts from banks
Tougher US Federal Reserve stress tests forced some of Wall Street’s top banks to rein in ambitious plans for pumping out cash to shareholders. But even those diminished returns spell a record payout to investors.
As the central bank’s annual stress tests ended on Thursday, the nation’s four largest lenders — JPMorgan Chase, Bank of America, Wells Fargo and Citigroup — said they would distribute more than $110bn through dividends and stock buybacks, sending their stocks higher in late trading. Even shares of Goldman Sachs and Morgan Stanley — which the Fed blocked from boosting total payouts — held steady.
The Fed’s decisions in the test provided some relief for investors after a record 13 straight days of declines in the S&P 500 Financials Index. In the hours after clearing the test, more than 20 firms described how they would reward their owners over the coming four quarters. Wells Fargo planned to boost payouts more than 70% to about $33bn, while JPMorgan signalled a 16% increase to $32bn.
"Today is about the capital announcements, and what we’re seeing is dividends going up more than 30% on average," said Marty Mosby, an analyst at Vining-Sparks IBG, as announcements were still rolling in. In addition, buybacks mean "share count is going to go down by about 6%-7%", boosting earnings per share, he said.
Wells Fargo rose 3.4% in late trading as of 6.40pm in New York. JPMorgan and Citigroup both advanced at least 1.6%.
The Fed also delivered some bad news. The regulator said it rejected initial proposals from six firms — JPMorgan, Goldman, Morgan Stanley, American Express, M&T Bank and KeyCorp — to make even higher payouts, forcing them to temper their requests. Never have so many firms taken that so-called mulligan (second chance) to finish the exam.
Goldman passed after agreeing to make payouts in line with the average of the past two years. Morgan Stanley maintained the level it paid in the past 12 months. Those plans could still leave them short of regulatory minimums in a severe crisis, the Fed projected. But the regulator let them proceed after considering the effects of one-time charges in the fourth quarter linked to US tax cuts — which are expected to boost future profits.
That leniency contrasted with past years, said David Wright, MD of Deloitte & Touche’s banking and securities regulatory practice.
"They felt they could provide some accommodation to a small number of firms," he said. "I wouldn’t expect this to have happened a few years ago under different leadership at the supervisory agencies."
The Fed also failed a US subsidiary of Deutsche Bank, citing "widespread and critical deficiencies" in its planning. The widely anticipated rejection limits the unit’s ability to send capital home to Germany and comes as senior executives try to bolster investor confidence. The Frankfurt-based firm said it’s working with regulators and making progress.
The Fed said State Street’s plan was approved on the condition that the company improves its methodology on calculating counterparty exposures under stressed scenarios. The New York-based bank said it "took a conservative approach".
Altogether, firms will distribute about 95% of their profits, the Fed projected, roughly in line with analysts’ estimates. That means that despite their stumbles in the tests, big banks may deliver the $170bn in combined payouts that Wall Street analysts had predicted for the coming 12 months — about $30bn more than in the previous four quarters.
Analysts had anticipated that some firms would probably struggle. Several estimated that Morgan Stanley would increase its payout only slightly and that Goldman Sachs would return less cash. Further hints of trouble emerged last week, when the pair barely passed the test’s first round, based on continuing payouts at past levels.
The Fed’s hypothetical scenarios were much harsher in 2018, including a 65% drop in stock prices and a US economic contraction of as much as 8.9%. The worst point in tests for the past three years didn’t exceed 7.5%. The scenarios 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 Fed proposed major revisions to its exam programme in April, which will probably be finalized later in 2018 and go into effect with 2019’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.
With Jesse Hamilton, Emma Kinery and Hannah Levitt