One calculation was consuming Wall Street on Friday.
Investors and bank executives were trying to work out whether the results of Thursday’s regulatory stress tests will force Goldman Sachs and Morgan Stanley to reduce the amount they expect to pay out to their shareholders.
Stock buybacks and dividends can help support stock prices, so any time they are smaller than expected, investors may be disappointed. Since the financial crisis, the largest U.S. banks must receive approval from the Federal Reserve to return capital to shareholders. The stress tests, which the Fed administers, are a crucial part of the determination of whether a bank has spare capital to distribute. Capital is a bank’s main financial defense against losses.
Under the stress tests, the Fed estimates how much capital a bank might have left after suffering big losses in a severe economic downturn. First, let’s say a bank enters the tests with capital that is equivalent to 8 percent of its assets and the stress test, at its worst point, takes capital down to 4 percent of assets. What then matters is how far that 4 percent is above the Fed’s minimum capital requirement.
If in this hypothetical case the minimum level is 3 percent, the bank would be free to pay out a dollar amount equivalent to 1 percent of its assets. Put another way, a bank with $1 trillion in assets could distribute as much as $10 billion to shareholders. The bank, of course, might decide to pay out less, say $7 billion, because it doesn’t want to risk going below the minimum in future tests.
On Thursday, Goldman Sachs and Morgan Stanley nearly hit their minimums on a capital measurement called the supplementary leverage ratio. Under the worst-case scenario, Goldman Sachs’s ratio fell to 3.1 percent, just above the Fed’s 3 percent minimum, and Morgan Stanley’s declined to 3.3 percent.
When bank analysts saw these results, they did the following sort of calculation.
In Goldman’s case, the firm had $1.39 trillion in assets and other positions at the end of first quarter. The 0.1 percentage point difference between the minimum requirement and the stress test low point is equivalent to $1.39 billion. Given that Goldman Sachs bought back $6.7 billion of stock and paid out $1.2 billion in dividends last year, it would appear the bank might have to reduce the amount it distributes to shareholders.
For Morgan Stanley, the 0.3 percentage point difference is equivalent to $3.27 billion, which is less than the $3.75 billion in stock that the bank bought back last year. Morgan Stanley also paid out $2.1 billion in dividends in 2017.
But the above example probably doesn’t capture everything that goes on when making these calculations. In the past, banks that have been close to the minimum level in the tests have gone on to announce higher-than-expected distributions.
The mystery won’t last for long. The banks submitted their capital plans before the stress test results were revealed, and they will have a chance to resubmit them over the next few days if they were asking to pay out too much.
On Thursday, in its Comprehensive Capital Analysis and Review, the second leg of the stress-testing process, the Fed will reveal whether it objected to any of the bank’s plans for paying out capital. The Fed will also say which banks changed the size of their payouts from their original request. Once the Fed has made its capital review public, the banks typically announce how much stock they intend to repurchase in the coming months.
Goldman Sachs’ stock on Friday was down 0.42 percent, and Morgan Stanley’s fell 1.8 percent. The wider stock market, measured by the S&Poor’, was up 0.2 percent.
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