The Fed’s Stress Test: The Winners And Losers Of Banks’ Proposed Capital Plans

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The Federal Reserve published its much-awaited report detailing its consent and dissent to capital plans proposed by the country’s biggest banks this Thursday. [1] And while most of the banks got the mandatory clearance they sought to return more cash to investors through dividend hikes and share repurchases, Ally Financial and BB&T Corp. were not so lucky as the Fed rejected their capital plans for the year.

Quite notably, JPMorgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS) received only a conditional no-objection to their plans with the Fed directing them to submit new capital plans by September “to address weaknesses in their capital planning processes.”

We provided an overview of what the Fed had to say about the 18 banking institutions that were subjected to the stress test in our recent article, The Fed’s Stress Test: Summary, Results And Implications. And for those of you who are still wondering what the hype about the Fed’s stress test is all about, you might want to glance through our article The Fed’s Stress Test: Here’s Why It Matters.

See Full Analysis for: JPMorgan ChaseGoldman Sachs

Dividends and The Banking Sector; And Why The Fed Figures In The Picture

The banking sector has traditionally attracted investors looking for dividends. However, in the aftermath of the global economic downturn of 2008, the banks had to cut their dividends to shore up capital – which makes sense considering the number of banks that went under during that period. Along the way, the deteriorating debt situation in Europe forced a further delay in capital plans. It was only after the stress test last year that the banking giants could finally begin paying back shareholders for their patience.

So why does the Fed have to approve the banks’ dividend plans? After all, there is no such regulatory body for other industry sectors to determine how much dividend a company is allowed to pay.

To answer this question, we must first remember that one of the biggest components of any company’s capital plans for a period is the amount of cash the company intends to return to its investors over that duration. The company can increase payout to investors through either a dividend hike or through repurchase of its stock. This is no different for a bank. But since the economic downturn and the subsequent bailout of the banks, the Federal Reserve has primarily been interested in ensuring that the banks have enough capital reserves to be able to survive another economic downturn. And in its quest to build the banks’ capital strength, the Fed ended up shouldering the responsibility of making sure that the banks do not return too much of their cash.

So Investors In Which Bank Get To Break Out The Bubbly?

The Fed summarized its stand on the proposed capital plans of the country’s 18 biggest bank holding companies as shown in the table below: [2]

Non-objection Conditional non-objection Objection
American Express Goldman Sachs Ally Financial
Bank of America JPMorgan Chase BB&T
BNY Mellon
Capital One
Citigroup
Fifth Third Bancorp
Keycorp
MetLife
Morgan Stanley
PNC
Regions Financial
State Street
SunTrust
U.S. Bancorp
Wells Fargo

The Fed’s rejection of Ally’s plans are no surprise – the financial institution failed the stress test as announced last week and is in a rather precarious situation capital-wise given its liabilities to the bankrupt Residential Capital. BB&T figures on the same list because of its announcement earlier this month that it has to rework incorrectly calculated risk-weighed assets figure.

As for JPMorgan and Goldman, the conditional approval should serve as a course correction for their capital return plans as the Fed believes there are underlying weaknesses to their capital structure that need to be addressed first before the banks start handing out more cash to investors. As the Fed can reject a capital plan even on qualitative grounds, the ‘London whale’ trading loss for JPMorgan would no doubt have had a role to play in the Fed’s decision to ask the bank for a resubmission.

This is the third article in our series on the Fed’s 2013 Stress Test, and its implications for the public at large. In subsequent articles we will detail the results of the test for individual banks.

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Notes:
  1. Federal Reserve announces results of Comprehensive Capital Analysis and Review (CCAR), Federal Reserve Website, Mar 14 2013 []
  2. Comprehensive Capital Analysis and Review 2013: Assessment Framework and Results, Federal Reserve Website, Mar 14 2013 []
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