Fed Stress Tests: The Winners And Losers Of Proposed Capital Plans

by Trefis Team
Royal Bank of Scotland
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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 on Wednesday, March 26. [1] The detailed results of its annual Comprehensive Capital Analysis and Review (CCAR) for banks follows last week’s summary results highlighting the performance of 30 of the country’s largest bank holding companies in the stress test, which forms the quantitative cornerstone of the review process (see Fed Stress Test For Banks: Rationale, Results & Implications). While 25 of these firms saw the Fed give their capital plans for the year the green light, five of them had their plans rejected. As Zions was the only firm to fail in the stress test, the Fed’s objection to the capital plans of the other four firms was based on qualitative reasons.

Notably, Citigroup (NYSE:C) had its plan shot down, with the Fed observing that the bank had not sufficiently improved its capital planning process “in some areas that had been previously identified by supervisors as requiring attention.” [2] Besides Zions and Citigroup, the other three banks that have to resubmit their capital plans are HSBC North America, RBS Citizens and Santander – all of which were determined by the Fed to have “inadequate governance and weak internal controls.”

The Fed also mentions that Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS) had to resubmit their capital plans before they got their approval, as their original capital plans saw at least one of their post-stress test capital ratios fall below regulatory minimum levels.

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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 in 2012 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 period. The company can increase its payout to investors through either a dividend hike or through repurchases 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 what do the results mean for the banks who saw their capital plans approved, as well as for those whose plans were rejected? Banks that cleared the Fed’s regulatory hurdle are free to boost their dividends and repurchase shares as long as the total amount is in line with what they submitted to the Fed. This should help explain the flurry of press releases by these firms announcing dividend hikes, share buybacks or both on Wednesday.

As for the banks that failed the test, they are faced with two options: they could either resubmit their capital plans to the Fed and seek a fresh approval, or they could continue with their current capital plan (i.e. the plan that was approved last year). Either way, these banks are expected to fix the discrepancies in their capital planning and internal control policies as pointed out by the Fed as quickly as possible.

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  1. Federal Reserve releases results of Comprehensive Capital Analysis and Review (CCAR), Federal Reserve Website, Mar 26 2014 []
  2. Comprehensive Capital Analysis and Review 2014: Assessment Framework and Results, Federal Reserve Website, Mar 26 2014 []
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