Three Banks Uncover the Path to Payouts in the Fed’s Stress Test

(Bloomberg) -- Three banks have cracked the code on the Federal Reserve’s stress tests. Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley took advantage of an option to adjust their plans for dividends and stock buybacks after their original requests left them too little capital. Among 29 banks that passed the test Wednesday, they were the only ones that invoked the right to change their proposals in the week before the final results. While management teams and investors in the past have considered a resubmission a black mark on the annual exercise, a senior Fed official said Wednesday that regulators don’t look at it unfavorably. For Goldman Sachs, it was the second straight year it invoked that feature of the process. “The banks are really pushing to return excess capital and that’s good for shareholders,” Gerard Cassidy, an analyst at RBC Capital Markets, said in a phone interview. “That’s the reason we have mulligans. You want to use them.” After a global credit crisis in 2008, the Fed forced the nation’s largest lenders to reduce leverage and fund more of their operations with equity. That’s left investors hungry for payouts while suppressing a key measure of profitability known as return on equity. Goldman Sachs’s return on equity, which exceeded 30 percent before the crisis, has been 11 percent in each of the past three years. Firms using second chances can improve such returns by reducing equity and appease investors with payouts, Cassidy said. Other management teams may be too intimidated by regulators or conservative to attempt that approach, he said. ‘That’s Reckless’ “They think if they ask too much somebody might say, ‘That’s aggressive, that’s reckless,’” and regulators would fail them on qualitative grounds, Cassidy said. Regardless of capital strength, the Fed can prevent firms from increasing payouts if examiners deem internal controls, risk management or corporate governance lacking. Morgan Stanley won approval to increase payouts. The New York-based firm is boosting its dividend 50 percent and can buy back $3.1 billion of common stock over five quarters. Last year, it got permission to buy back $1 billion over four quarters. JPMorgan, which expects to require more capital as part of being placed in the Fed’s top category of systemically important firms, will increase its dividend 10 percent and buy as much as $6.4 billion of stock. That compares with a $6.5 billion buyback in the past year. While Goldman Sachs will boost its dividend 8 percent, it didn’t disclose a plan for stock purchases. In 2014, it paid out the highest percentage of earnings among the six largest U.S. banks. ‘True Intentions’ Regulators don’t hold it against banks if their original plans are so aggressive that the companies are forced to resubmit, or if they do it year after year, a senior Fed official told reporters Wednesday on a conference call. Regulators want to give banks a second chance because missing a regulatory minimum may result from paying out too much capital in a quarter when trading or loan losses peak, under the test’s hypothetical scenarios, the person said. Firms can change the timing of payouts or reduce them, the official said. Even so, banks should be careful, said Mike Alix, a former New York Fed official who helps run the financial services consulting group at PricewaterhouseCoopers LLP. “The Federal Reserve expects the capital plans to reflect the true intentions of firms, and if firms are providing capital plans that have higher levels than is reasonable on a consistent basis, that may give pause to the Fed,” he said in an interview. “While it seems that the incentives are to overshoot rather than undershoot, I think the Fed will consider, over time, the reasonableness of the asks.” To contact the reporters on this story: Dakin Campbell in New York at; Michael J. Moore in New York at

Download File