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Gloomy Stress Test Can Only Slow U.S. Banks' Buyback Train

Gloomy Stress Test Can Only Slow U.S. Banks' Buyback Train

(Bloomberg) -- U.S. banks are hitting the ceiling on how much cash they can hand back to shareholders.

After two years of surging payouts as regulators relaxed the reins on the biggest lenders, those firms are likely to boost dividends and buybacks by just 3% following this year’s stress test, according to analysts’ estimates compiled by Bloomberg. The Federal Reserve will release results of the first part of its annual review next week.

Payouts to shareholders started to ramp up in 2016 after the Fed was satisfied that the largest lenders had adequately beefed up loss buffers and improved risk management. Firms including Goldman Sachs Group Inc. and Morgan Stanley had their payouts limited in last year’s test because of a one-time hit to capital from a corporate-tax overhaul, and analysts expect those shackles to be removed this year.

“Payout ratios should be increasing for a few banks that had conditional approvals last year, but we’re expecting only modest changes in payout ratios for the remaining banks,” Brian Kleinhanzl, an analyst with Keefe, Bruyette & Woods, said in a note.

The 12 largest lenders are expected to boost payouts by $5 billion, after dividends and buybacks jumped by more than $30 billion each of the past two years. Still, the increase means they’ll likely pay out more than 100% of their annual profit.

Gloomy Stress Test Can Only Slow U.S. Banks' Buyback Train

The Fed will release this year’s results in two stages. The first step, coming on June 21, will show the hypothetical losses firms would face under Fed’s calculations. Then, on June 27, the Fed will incorporate the banks’ planned cash distributions to see if they can meet required minimum capital levels in a stressed environment.

The number of firms required to take part in the exercise has been halved after Congress tweaked the post-crisis banking law to ease the burden on mid-size banks.

Here’s what to watch for in the results of some key firms:

Goldman and Morgan Stanley

Goldman Sachs, Morgan Stanley and State Street Corp. were given passing grades in last year’s test even though their capital levels fell below the required minimums in the exam. The Fed was lenient because part of the decline was a result of one-time charges related to the 2017 tax overhaul, but it limited their payouts.

While Goldman Sachs and Morgan Stanley will probably keep their payouts below 100% of profits after this year’s exam, State Street’s could jump by 40 percentage points to 108%, according to KBW.

Investment Banks

Goldman Sachs and Morgan Stanley -- as well as other firms with large trading arms, like JPMorgan Chase & Co. -- could also benefit from the differences in this year’s test. While the 2019 scenario incorporates the harshest hypothetical recession and the worst increase in unemployment used in the tests so far, its stock and bond market losses are less severe than last year.

Gloomy Stress Test Can Only Slow U.S. Banks' Buyback Train

And the significant decline in U.S. Treasury yields that this year’s test foresees will help banks weather some of the hypothetical losses as their government bond portfolios are marked higher. Last year’s test didn’t predict a change in Treasury yields.

“Test this year makes more intuitive sense with a flight to safety in a stressed environment,” Morgan Stanley analysts led by Betsy Graseck said in a note this week. “This means hedges should work better.”

Bank of America

Bank of America Corp. has spent the last few years catching up to rivals JPMorgan and Wells Fargo & Co. in its payout ratios, and will likely return at least 100% of earnings to shareholders in 2019, according to Bloomberg Intelligence. Chief Executive Officer Brian Moynihan said last month that he aims to boost the dividend to a level equaling about 30% of earnings over time, up from about 21% in 2018.

What Bloomberg Intelligence Says

"Bank of America has the most room to increase its dividend payout among the largest U.S. peers, and aims to do so."
--Alison Williams, banks analyst
Click here to view the research

Deutsche Bank

Deutsche Bank AG’s U.S. operation is expected to fail the test for a fourth time as it struggles to clear the qualitative portion of the exam. The Fed this year has excused most banks from that portion, which evaluates risk management as well as data-collection capabilities and capital planning. Only five foreign banks’ U.S. units remain subject to it.

Foreign firms failing the test can’t repatriate profits earned in the U.S. For Deutsche Bank -- beset by money-laundering scandals, management turmoil and series of restructuring plans -- a failing grade will be yet another blow to investor confidence. The Fed placed the firm’s U.S. arm on a list of troubled lenders last year because of deficiencies in its internal oversight.

Who’s Missing

Regional lenders with assets between $100 billion and $250 billion are now subject to the stress test every two years instead of annually. That means banks including SunTrust Banks Inc. and Fifth Third Bancorp aren’t included in this year’s exam.

Those dozen firms will probably still announce their capital distribution plans the same day their tested peers do, analysts said. Those firms’ dividends and buybacks are estimated to rise by 3% in the next 12 months.

--With assistance from Daniel Taub.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl

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