Bank Stress Test Winners and Losers

As part of the Dodd-Frank financial reforms, the largest U.S. banks must submit their plans for dividends and buybacks to the Federal Reserve each year for approval.

In this Industry Focus: Financials clip, host Shannon Jones and contributor Matt Frankel discuss the winners and losers of the 2018 stress tests.

A full transcript follows the video.

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This video was recorded on July 2, 2018.

Shannon Jones: For the first part of the stress test, all 35 banks were able to pass that with pretty flying colors. It was the second part of the stress test that some banks actually stumbled. Let's talk a little bit about, what were some of the biggest surprises that came out of that?

Matt Frankel: Out of the 18 that were subject to having their capital plans reviewed, 15 got the green light. There were a few that were not doing so well. Deutsche Bank (NYSE: DB), this is their U.S. division, was the only one that had their capital plan outright rejected, meaning that they have to come back and resubmit it within a few months. The two big investment banks -- Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) -- were conditionally approved. I wrote an article on this, you guys can read it if you'd like to. The big effect of this is that Goldman Sachs and Morgan Stanley can't increase their capital spending this year on dividends and buybacks.

The reason for this, to make a long story short, is tax reform really killed them this year, for different reasons. Goldman Sachs had to deal with the repatriation of foreign profits. That was a change this year. Morgan Stanley had a big deferred tax asset on its balance sheet that became less valuable when the corporate tax rate dropped.

But, those two banks barely made it, capital-wise. They were much closer to the threshold than some of the other big banks. So, the Fed is hesitant to let them spend even more money on buybacks and dividends. They both submitted a revised version of what they wanted to do, and it consisted of keeping their capital levels constant this year. That got approved by the Fed.

As far as positive surprises go, Wells Fargo (NYSE: WFC) was probably the biggest positive surprise. I probably don't have to tell most listeners, Wells Fargo hasn't had the best couple of years, when it comes to their fake accounts scandal, the fallout from that, the other mini scandals along the way, and just recently, their punishment by the same Federal Reserve that says they're not allowed to grow until they improve. They actually got the approval to buy back more than twice the amount of stock that they did last year. One, that says a lot about how well-capitalized they are. Two, it also says a lot that their management's willing to do that, that they think that their stock is at such a compelling bargain right now that they're willing to spend over $25 billion on buybacks alone.

So, we had some winners, we had some negative surprises. But, in general, the capital plans were approved. Most of the big banks are significantly raising their dividends and buybacks. Banks like Bank of America, JPMorgan Chase, Citigroup, American Express, Capital One, all got approval for significant capital increases.

Jones: Yeah, absolutely! I'd have to agree, the positive surprise with Wells Fargo surprised and shocked many for a lot of different reasons. They can't really seem to stay out of the scandal news headlines.

Deutsche Bank, not so much of a surprise. They've really been on the struggle bus for quite some time. I know they've also had a trickle of some top executive departures recently, as well. So, not too terribly surprising. I think if anything, with Deutsche Bank -- this is, again, the U.S. arm of Deutsche Bank -- the Fed actually said there were widespread and critical deficiencies with that particular bank's capital planning controls. There are also weaknesses in their data capabilities, controls supporting its capital process, and even concerns with how the bank forecasts revenues and losses under stress. So many red flags for Deutsche Bank there.

Matthew Frankel owns shares of American Express and Bank of America. Shannon Jones has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.