GS Goldman Sachs Group Inc

By Liz Hoffman and Lalita Clozel 

Regulators cleared most of the largest U.S. banks to increase their dividends and share buybacks, but forced two Wall Street titans, Goldman Sachs Group Inc. and Morgan Stanley, to freeze those payouts at recent levels.

Thirty-four of the nation's 35 biggest lenders passed the second round of the Federal Reserve's annual "stress tests," which gauge whether banks are healthy enough to keep lending through an economic meltdown. They can now buy back shares and pay dividends, rewarding investors who have been eager to share in the bounty of near-record bank profits.

The Fed failed the U.S. unit of troubled lender Deutsche Bank AG, finding "widespread and critical deficiencies" in its controls and data. The Wall Street operation will be limited in sending profits back to its German parent, adding to the woes of a bank already struggling to make money and trimming its U.S. operations.

Among the big banks cleared Thursday for higher payouts to shareholders were the four biggest U.S. firms -- JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co.

Bank of America said it would increase its dividend 25% and buy back $20.6 billion in stock, up from $12.9 billion last year.

Now in their eighth year, the stress tests are intended to give the public confidence that banks are better prepared for the next crisis. Banks flunked with some frequency early on, but have fared better in recent years after raising hundreds of billions of dollars in capital and taking an ax to riskier businesses.

"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 Randal Quarles, the Fed's vice chairman for supervision.

This year's test was the toughest to date, laying out a doomsday scenario of double-digit unemployment, cratering home and stock prices, and soaring losses on credit cards and car loans.

Six banks, including JPMorgan and American Express Co., scaled back their original requests to win the Fed's approval.

"Banks have an imperfect crystal ball," said David Wright, a former Fed official who is now a consultant at Deloitte & Touche. "There's an incentive to guess aggressively rather than miss the opportunity to distribute capital."

Goldman Sachs and Morgan Stanley, which each fell below the minimum capital levels set by the Fed, were blocked from raising their total payouts but were cleared to distribute roughly what they had over the past year or so.

The problem for these two Wall Street giants wasn't a hypothetical trading blowup or loan losses, the Fed said, but rather the effect of the 2017 tax overhaul, which created a one-time hit to their capital levels. In the long run, the tax cuts are a boon to big banks, generating billions of dollars in savings.

The Fed's treatment of Goldman and Morgan Stanley -- a compromise without the black eye of failure -- was unprecedented and, to some bankers, a sign of an administration that is friendlier to Wall Street's interest.

State Street Corp., a custody bank that mostly holds assets for, and trades with, other big financial institutions, drew criticism from the Fed for how it assessed the risk of one of those trading partners going bankrupt. But the Fed said the firm can make payouts to investors.

For years following the crisis, banks paid out only a fraction of their profits to shareholders, socking the remainder away to build their loss-absorbing reserves. In 2013, the average bank paid out about 60% of earnings, according to Autonomous Research.

This year, the 34 banks in aggregate were approved to pay out 95% of their expected profits, according to a senior Fed official.

Citigroup and Wells Fargo got the green light to pay out more than 100% of expected profits over the coming year -- a sign that the Fed thinks those firms are safe enough to begin reducing the capital reserves they have built up since 2008.

Wells Fargo passed the test, defying some industry watchers who expected the Fed might use the exam to further express its displeasure at a stream of scandals at the San Francisco-based bank. It was cleared to more than double its buybacks, to $24.5 billion, and increase its dividend by about 10%.

Higher dividends and buybacks boost stock prices and improve metrics like total shareholder return, which often affects how much top bank executives are paid.

In the future, shareholders may have to contend less with wary regulators than with increasingly confident CEOs, who are looking at a growing economy and the prospect of regulatory rollback and are eager to invest profits back into the business.

"The ideal thing -- and which I think we'll get back to one day -- is that you use your excess capital to grow," JPMorgan CEO James Dimon said last month.

This was the latest regulatory black eye for Deutsche Bank, which last year had its U.S. operations downgraded to "troubled condition" by the Fed.

The bank said in a statement Thursday that it is making progress on its controls, and that the stress-test results won't affect the ability of the German parent company to return capital to investors.

--Ryan Tracy contributed to this article.

Write to Liz Hoffman at liz.hoffman@wsj.com and Lalita Clozel at lalita.clozel.@wsj.com

(END) Dow Jones Newswires

June 28, 2018 19:48 ET (23:48 GMT)

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