Most big US banks pass Fed's stress test

Since the 2006-07 financial crisis, management teams have largely proven the merit of their internal disaster planning to the Fed

Nearly all of the largest US banks are on steady enough footing to increase payouts to shareholders, the US Federal Reserve said , with just two subsidiaries of foreign banks failing its annual stress test.

The results show that big US banks have not only built up significant capital since the 2007-2009 financial crisis but that management teams have largely proven the merit of their internal disaster planning to the Fed. However, the Fed criticized some elements of Morgan Stanley's capital planning process, but still allowed the bank to move ahead with plans for a $3.5 billion stock repurchase program and a quarterly dividend hike while it rectifies the issues.

The regulatory thumbs up prompted a slew of announcements from banks who plan to buy back more stock or increase dividends, good news for investors who saw their banks shares hammered by Britain's vote last week to leave the European Union.

The two banks that failed, Deutsche Bank Trust Corporation and Santander Holdings USA, which are subsidiaries of Deutsche Bank AG and Banco Santander SA-have also failed in the past. "Broad and substantial weaknesses" persist in their capital planning processes, the Fed said.

The rejection of their capital plans - the third year in a row for Santander and the second straight year for Deutsche-means that they cannot return any profits .

The Deutsche Bank unit that failed holds its transaction and wealth management businesses in the United States. The bank is consolidating its US business into a new holding company on July 1 called DB USA Corp, a larger unit, which will have its capital plan reviewed by the Federal Reserve in 2018, the company said.

Despite their failures, Deutsche and Santander have improved, a senior Fed official said on a call with reporters. On a quantitative basis, all 33 banks that participated in the Fed's stress tests this year easily passed minimum capital requirements.

Those banks have more than doubled their capital since the crisis, adding more than $700 billion in common equity capital from the beginning of 2009, according to the Fed.

While the Fed's stress tests are only hypothetical scenarios and the evaluations are subjective, the process is forcing banks to be better prepared for real life events.

Market turmoil that followed the British referendum last week is a good example, said Mike Alix, a bank consultant at PricewaterhouseCoopers and a former supervisory official at the Federal Reserve Bank of New York.

"The benefits of CCAR are an absolute rise in capital ratios and risk management," said Alix.

The Fed's checks on the quality of risk management and capital planning "are driving improvements in governance, infrastructure and controls" at the banks, he added.

At least one bank each year has failed to have its capital plan approved since the Fed began issuing pubic verdicts in 2012. Those that have failed in the past, including Ally Financial and Citigroup passed this year, as did those that previously received "conditional" approvals, like Bank of America.

Morgan Stanley's conditional approval on Wednesday was the result of "material weaknesses" in the way it designs and models stressful scenarios. Morgan Stanley has until Dec 29 to resubmit its capital plan and rectify those shortcomings.

Although the Fed said the problems deserve attention, they were not substantial enough to undermine Morgan Stanley's quantitative stress test success.

The bank would still produce a ratio of high quality capital to assets of at least 7.7 per cent in severely adverse scenario, well above the regulatory minimum.

Morgan Stanley's announcement on Wednesday afternoon that it would repurchase up to $3.5 billion of additional common stock was above the average analyst estimate of $2.8 billion, according to FactSet StreetAccount. It also said it would raise its quarterly common stock dividend to 20 cents, above the 18-cent analyst estimate.

Morgan Stanley shares rose 0.8 per cent to $25.43 in after-hours trading.

Several other banks that passed the Fed's test, including JPMorgan Chase & Co, Bank of America, Citigroup, Goldman Sachs Group and Wells Fargo & Co, also said they would buy back more stock or increase dividends.

The results, from a process known as CCAR, come after the Fed released results of a separate stress test, dubbed DFAST, last week. CCAR is a more nuanced examination, in which the Fed models unique circumstances for each individual bank, and can fail banks for the way they go about capital planning as well as whether they technically pass a numerical threshold.

Banks had a few days to resubmit their capital plans last week if they felt that they were on shaky ground. M&T Bank was the only bank to do so.