The Federal Reserve is reigning in banking giants Goldman Sachs and Morgan Stanley from boosting their total dividend payouts and stock buybacks.
The decision is the result of the central bank's second round of its annual stress tests. The Federal Reserve has given the OK to 32 of the 35 biggest banks in the U.S. to raise their dividends and buy back shares, judging their financial foundations sturdy enough to withstand a major economic downturn.
The new tax law that took effect in January helped tip Goldman and Morgan Stanley's capital reserves below required levels under the hypothetical stress, the Fed said. It was pegged as a one-time impact of the tax law. The Fed rejected outright the capital plan of the U.S. holding company of Germany's Deutsche Bank, citing weaknesses in its assumptions for forecasting revenues and losses.
State Street Corp. gained Fed approval on condition that it improve its analysis of hypothetical lending risks with other big banks.
The yearly check-up tests the banks to determine if their current plans for paying out capital to shareholders would still allow them to keep lending if hit by another financial crisis and severe recession. They have now been approved to pay out to shareholders about 95 percent of their total net revenue over the next four quarters.
The Fed said it applied its toughest-ever "severely adverse" scenario for the economy in this year's tests to see how the banks would fare.
All the banks have at least $50 billion in assets.
After the results were made public, several big banks quickly announced they were boosting their dividends and would increase the amount of stock they plan to buy back this year.
"Today is about the capital announcements, and what we're seeing is dividends going up more than 30 percent on average," Marty Mosby, an analyst at Vining-Sparks IBG LP, told Bloomberg News.
JPMorgan Chase raised its quarterly dividend to 80 cents a share, up from 56 cents a share. The company also announced a plan to repurchase $20.7 billion in stock this upcoming cycle. Wells Fargo raised its dividend to 43 cents a share from 39 cents a share, and announced $24.7 billion in stock repurchases. American Express said its new dividend would be 39 cents a share, up from 35 cents, and it would repurchase $3.4 billion in new stock.
The latest test results "demonstrate that 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," Vice Chair Randal Quarles, who is the Fed's top bank supervisor, said in a statement.
The tests were mandated by Congress in the wake of the crisis that plunged the U.S. into the worst economic downturn since the Great Depression of the 1930s. They were designed to restore badly shaken confidence in the U.S. financial system. During the crisis, banks large and small across the U.S. received hundreds of billions in taxpayer funds to prop them up.
Nearly a decade later, banking industry profits have been steadily rising and banks have been lending more freely.
The dividend increases and share buyback plans are important to ordinary investors, and to banks. The banks know that their investors suffered big losses in the crisis, and they are eager to reward them. Some shareholders, especially retirees, rely on dividends for a portion of their income. For the banks, raising dividends can drive up their share prices and make their stock more valuable to investors.
But raising dividends is costly, and regulators don't want banks to run down their capital reserves, making them vulnerable in another recession. Buybacks also are aimed at helping shareholders. By reducing the number of a company's outstanding shares, earnings per share can increase.
With the 35 banks holding about 80 percent of total assets of all banks operating in the U.S., the results showed strength in an industry that nearly brought down the financial system — and has recovered robustly nearly a decade after the 2008-09 crisis.
Now the banks have a total of about $1.2 trillion in capital reserves as of the fourth quarter of last year, an increase of some $800 billion over the beginning of 2009, in the depths of the crisis, according to the Fed.
The Fed's most extreme hypothetical scenario in this year's tests envisions the U.S. economy falling into a deep recession causing the stock market to plunge 65 percent by early 2019 amid surging volatility. Under that "severely adverse" scenario, unemployment — now at an 18-year low of 3.8 percent — climbs to 10 percent.
The Fed said the 35 big banks would suffer $578 billion in loan losses under the most dire scenario. That's up from $383 billion in losses for 34 banks last year.
The banks tested by the Fed are: Ally Financial, American Express, Bank of America, Bank of New York Mellon, Barclays, BB&T, BBVA Compass, BMO Financial, BNP Paribas, Capital One, Citigroup, Citizens Financial, Credit Suisse, Deutsche Bank, Discover, Fifth Third, Goldman Sachs, HSBC, Huntington Bancshares, JPMorgan Chase, KeyCorp, M&T, Morgan Stanley, MUFG, Northern Trust, PNC, Regions Financial, Royal Bank of Canada, Santander, State Street, SunTrust, TD Group, UBS, U.S. Bancorp and Wells Fargo.