Fed Test Fails Deutsche Bank, Forces JPMorgan, Goldman, Four Others to Limit Payouts

Tougher Federal Reserve stress tests forced six U.S. banks to scale back proposals for doling out more cash to shareholders, while failing Deutsche Bank's US unit on "qualitative" grounds:

  • The Fed failed the 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.
  • Goldman Sachs Group Inc. and Morgan Stanley -- agreed to freeze payouts at previous years’ levels. Both banks were required to rein in their dividend and stock buyback plans after the Fed warned their initial, more bullish, proposals would have left them with inadequate capital buffers.
  • JPMorgan Chase, American Express, KeyCorp and M&T Bank Corporation also rethought their original plans for payouts to shareholders, although they got the thumbs up after submitting more modest plans in the past week, the Fed said.

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.

As the FT notes, given the disappointing results on Thursday for some banks, the industry’s overall payout ratio — capital distributed as a proportion of earnings — was expected to remain roughly unchanged from last year at about 95 per cent.

Even with the more conservative capital plans, Goldman and Morgan Stanley fell below some required capital thresholds. Yet the Fed gave the less punchy payouts the go-ahead anyway. Officials said weakness in the stress test partly reflected the accounting impact of landmark tax reforms that Mr Trump signed into law last year. Randal Quarles, the Fed’s regulatory chief, said they had created “one-time challenges”.


The results overall were weaker than last year, although Fed officials noted that the regime had become stricter this year. They also said the tax reforms reduced banks’ capital ratios just as the stress tests were beginning, because the cut in the corporate tax rate from 35 per cent to 20 per cent cut the value of deferred tax assets. Furthermore, Trump reforms eliminated a beneficial tax treatment that had enabled banks to smooth their earnings by carrying losses forwards or backwards from periods of crisis.

And here are select banks' capital plans announced in response:

  • Wells Fargo to Buy Back Up to $24.5b Shrs, Boosts Div to 43c/shr, up from current 39c/shr
  • JPMorgan Chase to buy back up to $20.7b of shares, raises dividend to 80c/shr from 56c/shr;
  • Bank of America to buy back up to $20.6b of shares, raises dividend to 15c/shr
  • Citi to Buy Back Up to $17.6b Shares, boosts dividend to 45c/shr from 32c, est. 41c.
  • Goldman Sachs to Buy Back up to $5.0b Shares, Boosts Div to 85c from 80c
  • Morgan Stanley to Buy Back Up to $4.7b of Stock, Boost Qtr Div to $0.30/shr from $0.25/shr
  • American Express To Buy Back Up To $3.4b Shares, boosts qtrly dividend to 39c/share, from 35c/share
  • U.S. Bancorp to Buy Back up to $3B Shares, Boosts dividend to 37c/shr from 30c/shr
  • PNC Financial to Buy Back up to $2.0B Stock, boosts dividend to 95c/shr from 75c/shr
  • Capital One to Buy Back up to $1.2B Stock, keeps dividends at 40c/shr
  • Ally To Buy Back Up To $1b Shares, Boosts Dividend to 15c/shr from 13c/shr

And the market response, no surprise, is favorable as has been the case after every prior CCAR result:

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The Full Fed statement is below (link):

As part of its annual examination of the capital planning practices of the nation's largest banks, the Federal Reserve Board on Thursday did not object to the capital plans of 34 firms and objected to the capital plan of one firm.

Due in part to recent changes to the tax law that negatively affected capital levels, two firms will maintain their capital distributions at the levels they paid in recent years. Separately, one firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Comprehensive Capital Analysis and Review, or CCAR, in its eighth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms' planned capital actions, such as dividend payments and share buybacks. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

"Even with one-time challenges posed by changes to the tax law, the CCAR results demonstrate that the largest banks have strong capital levels, and after making their approved capital distributions, would retain their ability to lend even in a severe recession," said Vice Chairman Randal K. Quarles.

When evaluating a firm's capital plan, the Board considers both quantitative and qualitative factors. Quantitative factors include a firm's projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm's capital planning process, which incorporates risk management, internal controls, and governance practices that support the process.

This year, 18 of the largest and most complex banks were subject to both the quantitative and qualitative assessments. The 17 other firms in CCAR were subject only to the quantitative assessment. The Board may object to a capital plan based on quantitative or qualitative concerns.

The Board objected to the capital plan from DB USA Corporation due to qualitative concerns. Those concerns include material weaknesses in the firm's data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress.

The Board issued a conditional non-objection to the capital plans of both Goldman Sachs and Morgan Stanley and both firms will maintain their capital distributions at the levels they paid in recent years, which will allow them to build capital over the next year. Each firm's capital ratios, under the capital plans they originally submitted and with the one-time capital reduction from the tax law changes, fell below required levels when subjected to the hypothetical scenario. This one-time reduction does not reflect a firm's performance under stress and firms can expect higher post-tax earnings going forward.

The Board also issued a conditional non-objection for the capital plan from State Street Corporation. The stress test revealed counterparty exposures that produced large losses under the hypothetical scenario, which assumes the default of a firm's largest counterparty under stress. The firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Credit Suisse Holdings (USA); Discover Financial Services; Fifth Third Bancorp; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; RBC USA Holdco Corporation; Regions Financial Corporation; Santander Holdings USA, Inc.; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; UBS Americas Holdings LLC; and Wells Fargo & Company.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio--which compares high-quality capital to risk-weighted assets--of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.

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PREVIEW

After 13 days straight down, bank stocks staged a very modest comeback today ahead of tonight's hope-strewn Comprehensive Capital Analysis and Review (CCAR). However, given the performance since the last CCAR, investors better hope it's different this time...

As a reminder, all 35 banks passed the stress test last week as The Fed confirmed they would all be fine if stocks crashed 65% and VIX spiked to 60.

That test examined hypothetical losses with dividends continuing as before. The second phase (results announced today) looks at requests for future stock buybacks and higher dividends.

There's technically two ways to "fail" the stress test -- quantitatively and qualitatively. But no one has failed on a quantitative basis since 2013 because the Fed allows banks to take a "mulligan."

The stress tests showed Goldman Sachs and Morgan Stanley potentially at risk, and as a reminder, Wells Fargo is under Federal Reserve restrictions and all eyes are on whether Deutsche Bank is allowed to do anything.

Specifcally analysts have grown more skeptical that GS/MS can increase their payouts -- or in Goldman’s case, that it can even maintain last year’s level.

“We don’t get to see all the details of how the Fed gets to its numbers, but it’s still hard to fathom how they can meet pre-test expectations,” said Brian Kleinhanzl at Keefe, Bruyette & Woods. “The math just doesn’t work.”

And analysts aren’t confident that Deutsche Bank AG’s U.S. holding company can pass a key part of the test: the qualitative review of risk controls, internal oversight and other aspects of management. The bank’s U.S. unit already was placed on a Fed list of troubled lenders because its systems were deemed insufficient.

“It’s pretty hard to expect a positive surprise for the state of Deutsche Bank’s controls,” said Markus Riesselmann, an analyst at Independent Research in Frankfurt. “Sadly, we’re all pretty much used to bad news around Deutsche Bank, so a negative result won’t necessarily hurt their share price.”

For now, most banks' dividends are well above their previous peak, but some still lag...

So what were the results?

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Minutes before the official release time, BB&T filed an 8-K saying they passed the Fed's annual stress test. They boosted their quarterly dividend by 3 cents to 40.5 cents. They're also doing $1.7 billion in share repurchases.

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MS,GS are modestly lower; JPM, BAC, and C are higher...

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Full CAR Results: