Coverage: Most big banks pass stress test

The Federal Reserve Board announced Wednesday that 31 out of 33 big banks operating in the United States passed its stress tests, which are conducted to see how they would fare in a financial crisis, allowing them to raise dividends and buy back stock.

Ryan Tracy and Donna Borak of The Wall Street Journal had the news:

Big firms such as Bank of America Corp. and Citigroup Inc., which struggled on the tests in recent years, passed this time. Morgan Stanley also passed but received a bit of a rebuke. The Fed said it found “weaknesses” in internal risk- management processes and required the bank to submit a revised capital plan by the end of the year, though it will still be able to return capital in the meantime.

Morgan Stanley Chairman and Chief Executive James Gorman said that the firm is able to increase its capital return to shareholders for the fourth consecutive year, adding “we are committed to addressing the Fed’s concerns about our capital planning process and fully expect to meet their requirements within the established time frame.”

The U.S. banking units of two foreign firms, Deutsche Bank AG and Banco Santander SA, were flunked, due to Fed concerns about their ability to measure risks. It was the second year in a row the German bank failed and the third consecutive failure for the Spanish firm.

Matt Krantz of USA Today focused on the three banks that were flagged:

All 33 banks passed the first round of tests announced last week, but the Fed took issue with the capital plans of two banks, Deutsche Bank Trust and Santander Holdings USA, in round two. Both have been working to shore up their reserves and build systems to manage their risk, but have more to do in the eyes of the Fed. The Fed’s stress tests measure banks’ preparedness for a major financial shocks.

Morgan Stanley (MS) was the only major U.S. bank to get negatively singled out by the Fed. While the Fed didn’t object to Morgan Stanley’s capital plan, it is forcing the bank to resubmit its plans by the fourth quarter of this year “to address weakness in its capital planning processes,” the Fed’s release stated. Morgan Stanley passed the first part of the stress test, which looked at the company’s reserves on an objective, not subjective, basis. Since it passed the first part of the stress test, Morgan Stanley announced plans late Wednesday to boost its quarterly dividend by 33% to 20 cents a share.  The firm also authorized a $3.5 billion stock buyback program.

Wednesday’s stress test is the second part of an annual review of banks that’s required as part of the Dodd-Frank reforms following the financial crisis of 2008 and 2009. The first test, reported last Thursday, is mostly a mathematical exercise that quantifies whether the banks have the adequate resources to withstand a serious economic shock. Wednesday’s stress test has more qualitative variables that go in the formula to determine who passes and who doesn’t. In this test, the Fed is looking for banks to be strong in the area of capital planning, risk management, oversight and proper checks and balances. The fact that all 33 banks passed the first test shows just how much stronger the financial sector is now, says Ernie Patrikis, partner of law firm White & Case. “In terms of safety and soundness, these banks are safe and sound,” he says.

Nathaniel Popper and Michael Corkery of the New York Times noted that the Fed was comfortable with banks after the Brexit vote:

On Wednesday, a Fed official said that even with the concerns raised, the stress test results suggest that banks would be able to withstand an event like Britain’s exit from the European Union, which has rocked bank stocks over the last week.

Since the financial crisis, banks have been required to create large capital barriers to cushion against losses from a recession or market shock. While the financial system has not encountered any problems close to the mortgage losses of 2008, banks have been able to withstand more recent challenges like the steep drop in oil prices and the turmoil in Europe.

While tougher capital requirements may be helping to stabilize the banks, they are hampering profitability. The stock prices of many large banks have languished as investors question whether these companies can increase their profits substantially in such a stringent new regulatory environment.

The stress test results announced Wednesday are no doubt a welcome relief, in particular, to Bank of America and Citigroup, which have had difficulty passing the test unconditionally in past years. Both banks have spent tens of millions of dollars and assigned some of their top executives to the task of ensuring that they gain the Fed’s approval.