Goldman, JPMorgan Ordered to Fix Capital Planning by Fed

March 14 (Bloomberg) -- Goldman Sachs and JPMorgan the world’s biggest trading firms, must submit new capital plans to regulators to address weaknesses their planning processes found by the Federal Reserve. Julie Hyman reports on Bloomberg Television's "Street Smart." (Source: Bloomberg)

Goldman Sachs Group Inc. and JPMorgan Chase & Co., the world’s biggest trading firms, must submit new capital plans to regulators to address weaknesses the Federal Reserve found in their planning processes.

The central bank didn’t object to the capital plans of the two New York-based companies, and approved proposals from 14 other banks, the Fed said yesterday in a report. Capital plans submitted by Ally Financial Inc. and BB&T Corp. were rejected, while American Express Co., the biggest U.S. credit-card issuer by customer spending, revised its submission to win approval.

The deficiencies found at Goldman Sachs and JPMorgan related to projections of losses and revenue, according to a Fed official. While the two firms can immediately implement dividend and buyback plans, they must fix the weaknesses and resubmit their proposals by the end of the third quarter, the official said. Regulators, intent on preventing a repeat of the 2008 financial crisis, have run annual stress tests to see how the largest lenders would fare in a recession or economic shock to ensure that banks don’t jeopardize the financial system.

Goldman Sachs and JPMorgan exhibited weaknesses in their capital planning that were “significant enough to require immediate attention, even though those weaknesses do not undermine the quantitative results of the stress tests for that firm or the overall reliability of the firm’s capital-planning process,” the Fed said in a report on the test results.

Photographer: Peter Foley/Bloomberg

Traders work at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange. Close

Traders work at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange.

Close
Open
Photographer: Peter Foley/Bloomberg

Traders work at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange.

Goldman Dividend

Goldman Sachs probably would be left with a Tier 1 common equity ratio of 5.26 percent in a sharp economic downturn, the Fed said yesterday. JPMorgan’s ratio was 5.56 percent. Those were the two lowest scores among banks whose capital plans were approved. Goldman Sachs and JPMorgan also had the highest trading losses under the Fed’s scenario and overestimated by more than a percentage point their Tier 1 common equity ratio under the stress scenario.

Capital plans are proposals by banks to disburse dividends and repurchase shares, payouts that were curtailed during the financial crisis. After the Fed’s announcement, JPMorgan said it intends to buy back $6 billion of common stock and increase the dividend to 38 cents from 30 cents. Goldman Sachs said in a statement that it passed the tests and didn’t disclose its plan.

Goldman Sachs last year raised its dividend twice and repurchased $4.64 billion of stock after winning Fed approval. JPMorgan boosted its quarterly payout to 30 cents a share from 25 cents after last year’s stress test and authorized a $15 billion stock-repurchase program. That buyback program was scaled back after the firm disclosed a credit-derivatives trading loss that ballooned to more than $6.2 billion.

Jamie Dimon

JPMorgan Chief Executive Officer Jamie Dimon, 57, and Chief Financial Officer Marianne Lake, 43, signaled earlier this year that the bank would request a higher dividend and lower buyback amount.

Goldman Sachs, the world’s biggest securities firm before converting to a bank in 2008, generates most of its revenue from securities trading and investing its own money. The company still marks the value of most of its holdings to market prices every day, which can lead to more volatile fluctuations than at banks that recognize changes more gradually.

Morgan Stanley had a 5.62 percent Tier 1 common ratio including its plan to buy the remaining 35 percent of its brokerage joint venture with Citigroup Inc., the Fed said yesterday. New York-based Citigroup has an 8.22 percent ratio when including its capital plan, which the bank said yesterday is $1.2 billion of buybacks and no dividend increase.

Financial Crisis

Analysts have said they expect banks to increase payouts to the highest since 2007 after lenders cut dividends to token amounts during the financial crisis and built up capital ratios in the following years.

The Fed last week disclosed how banks performed in a hypothetical recession in which U.S. unemployment peaks at 12.1 percent, home prices fall 21 percent and stocks plunge 52 percent.

Yesterday’s test, known as the Comprehensive Capital Analysis & Review, required the 18 firms to submit plans for managing their capital, which could include buying back shares and boosting payouts. The central bank then gauged how strong each bank would be with the funds that remained.

For the first time, firms were allowed to revise those plans and immediately resubmit a new proposal for approval. The option came after Citigroup and SunTrust Banks Inc. had their capital plans rejected last year while staying above the 5 percent minimum without those plans.

Core Equity

The Tier 1 common ratio measures a bank’s core equity, made up of common shares and retained earnings, divided by its total assets adjusted for risk using global banking guidelines.

The ratio grew especially important during the financial crisis as investors applied extreme markdowns on bank portfolios to see whether firms had enough core equity to absorb additional losses or the potential for balance-sheet growth.

“You’re going to see a lot of pundits and strategists saying the banks are back, they are healthy, this is the catalyst to come back in and buy them,” said Matt McCormick, who helps oversee $7.7 billion at Cincinnati-based Bahl & Gaynor Investment Counsel Inc. “They are healthier, but from a trade perspective the money center banks have had a great 2012 and nice run year to date. I would take profits.”

Souring Debts

Projected losses for the 18 banks under a scenario of deep recession and peak unemployment of 12.1 percent would total $462 billion over nine quarters, the Fed said last week. The aggregate Tier 1 common capital ratio would fall from an actual 11.1 percent in the third quarter of 2012 to 6.6 percent in the fourth quarter of 2014 including the banks’ original capital- plan submissions. The firms represent more than 70 percent of the assets in the U.S. banking system.

In the scenario, the 18 lenders would lose $316.6 billion on souring debts, led by Bank of America Corp. The Charlotte, North Carolina-based firm would lose $57.5 billion, followed by Citigroup, with $54.6 billion. JPMorgan and San Francisco-based Wells Fargo & Co. would lose almost $54 billion apiece.

U.S. banks have grown stronger since the crisis. The Fed said in November the largest banking groups had almost doubled their Tier 1 common capital to $803 billion in the second quarter of last year from $420 billion in the first quarter of 2009. Dimon said last month that banks are accumulating more capital than they need.

Basel Rules

Still, some large lenders haven’t reached capital ratio requirements under new rules set by the Basel Committee on Banking Supervision, which may have caused them to be cautious in their requests, said Richard Staite, a London-based analyst at Atlantic Equities LLP.

“Capital return including buybacks will be capped by an increased emphasis on meeting the full Basel III capital requirements by year-end,” Staite wrote in a note to investors before the announcement. “Valuations are now higher and buyback requests likely to be more measured.”

The KBW Bank Index, which tracks shares of 24 U.S. banks such as JPMorgan, State Street Corp. and McLean, Virginia-based Capital One Financial Corp., advanced 12 percent this year through yesterday, compared with the 9.6 percent gain for the benchmark Standard & Poor’s 500 Index.

To contact the reporters on this story: Michael J. Moore in New York at mmoore55@bloomberg.net; Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.