Deutsche Bank Fails Federal Reserve Stress Test

by Ike Obudulu Posted on June 29th, 2018

Washington D.C., USA: The US Federal Reserve said on Thursday that Deutsche Bank AG (DBKGn.DE) U.S. operations failed the central bank’s annual stress test due to “widespread and critical deficiencies” in its risk management.

The Fed’s yearly stress tests are meant to determine if big banks are strong enough to sustain a major economic downturn. Thursday’s qualitative test looked at capital planning, including share buybacks and dividend payments.

The Fed also placed conditions on three banks that passed the test. Goldman Sachs Group Inc (GS.N) and Morgan Stanley (MS.N) cannot increase their capital distributions and State Street Corp (STT.N) must improve its counterparty risk management and analysis, the Fed said.

Deutsche Bank last week easily cleared the Fed’s easier first hurdle that measures its capital levels against a severe recession, the strictest ever run by the Fed.

Thursday’s second test focuses on how the bank’s plan for that capital, such as dividend payouts and investments, stands up against the harsh scenarios.

While the bank passed an earlier set of tests, it’s not the first time that the German banking giant has been unable to pass a US annual stress test, having failed similar tests in 2015 and 2016.

Deutsche’s negative result came after the Federal Reserve carried out its second round of annual stress tests, where it found that 32 out of the 35 major banks in the US had passed the test. As a result, the banking authority gave the approval for these financial institutions to raise dividends and buy back shares.The US regulator gave conditional approval to Goldman Sachs and Morgan Stanley whose capital levels were adversely affected during the test by changes to the US tax code.

Randal Quarles, the Fed’s newly appointed vice chairman for banking supervision, said in a statement that Thursday’s 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.”

‘Critical deficiencies’ in Deutsche Bank operations

The notable exception was Deutsche Bank’s American operations. The Fed said it “objected to the capital plan of DB USA Corporation because of widespread and critical deficiencies across the firm’s capital planning practices.”

“Concerns include material weaknesses in the firm’s data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress,” the US central banking authority added in a statement.

Ultimately, the Federal Reserve concluded that if Deutsche Bank was hit by an economic downturn or financial crisis, the bank  would be in danger due to poor data capabilities and internal controls, bad forecasts for revenue and losses under stress, and substandard internal audits.

Deutsche Bank, Europe’s second-largest lender, received the news in the midst of concerns from shareholders, who had expressed serious doubts about the bank’s health. The German banking giant saw its shares hit a two-year low on the German stock exchange on Wednesday.

Changes required at Deutsche Bank

In response to the results, Deutsche said it was making significant investments to improve its US subsidiary’s capital planning capabilities, as well as controls and infrastructure.

“DBUSA continues to make progress across a range of programs and will continue to build on these efforts and to engage constructively with regulators to meet both internal and regulatory expectations,” Deutsche bank said in a statement.

Deutsche Bank said it had made significant investments to improve its capital planning capabilities as well as controls and infrastructure at its U.S. subsidiary and would work with regulators to “continue to build on these efforts.

Failing the US stress test is not expected to affect the banks’ ability to pay dividends to shareholders. But it will require Deutsche to make changes to its US operations, such as substantial investment in technology, operations, risk management and personnel, as well as changes to its governance.

While failing the U.S. stress test would not likely affect the bank’s ability to pay dividends to shareholders, it will require Deutsche Bank to make substantial investment in technology, operations, risk management and personnel, as well as changes to its governance.

It also means the bank would not be able to make any distributions to its German parent without the Fed’s approval and could potentially result in the bank further paring back some of its U.S. operations.

The newly created U.S. subsidiaries of six foreign lenders, Deutsche Bank, Credit Suisse Group AG (CSGN.S), UBS Group AG (UBSG.S), BNP Paribas SA (BNPP.PA), Barclays Plc (BARC.L) and Royal Bank of Canada (RY.TO), went through the test for the second time this year had their results publicly released for the first time.

Deutsche Bank’s results cover DB USA Corp, a holding company with $133 billion in assets, according to Deutsche Bank’s March filings. This includes all of Deutsche Bank’s non-branch U.S. assets, including its mortgage lending and debt financing subsidiary, and its sizable Wall Street broker-dealer trading business.

Goldman Sachs, Morgan Stanley face curbs

In a press release, Goldman said it would maintain stock buybacks at $5 billion over the coming year, while keeping its quarterly dividend at 80 cents a share at least through the second quarter of 2019. Combined, the payouts will total up to $6.3 billion — less than the $6.42 billion projected by analysts with the brokerage Keefe, Bruyette & Woods in a May 17 report. According to analysts at RBC Capital Markets, Goldman had been approved for nearly $10 billion of payouts in the Fed’s 2017 stress tests.

Morgan Stanley said in a press release that its planned payouts of $6.8 billion would be “consistent” with the prior year’s levels.

JPMorgan Chase Bank,  Bank of America , Wells Fargo increase dividends, plan stock buybacks

The publication of the stress-test results triggered a slew of releases from banks announcing increases in their dividends and planned stock buybacks.

JPMorgan said its quarterly dividend would climb to 80 cents a share from 56 cents, starting in the third quarter, while Bank of America will boost its dividend by 25% to 15 cents a share.

A big winner in the Fed’s process was Wells Fargo, which was hit by regulators earlier this year with a ban on future asset growth following a series of scandals in which customers were allegedly mistreated.

Wells Fargo received a “non-objection” to its capital plan, and in a press release the bank announced plans to increase the quarterly dividend to 43 cents a share from 39 cents, while more than doubling stock buybacks to as much as $24.5 billion.

Some analysts and investors had speculated that Wells Fargo might fail the Fed’s test on qualitative grounds, as was the case for the Deutsche Bank unit.

Wells Fargo shares jumped 4% in after-hours trading Thursday to $55.30 a share, according to FactSet.

Federal Reserve releases results of Comprehensive Capital Analysis and Review (CCAR)

As part of its annual examination of the capital planning practices of the nation’s largest banks, the Federal Reserve Board on Thursday did not object to the capital plans of 34 firms and objected to the capital plan of one firm.

Due in part to recent changes to the tax law that negatively affected capital levels, two firms will maintain their capital distributions at the levels they paid in recent years. Separately, one firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Comprehensive Capital Analysis and Review, or CCAR, in its eighth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms’ planned capital actions, such as dividend payments and share buybacks. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

“Even with one-time challenges posed by changes to the tax law, the CCAR 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,” said Vice Chairman Randal K. Quarles.

When evaluating a firm’s capital plan, the Board considers both quantitative and qualitative factors. Quantitative factors include a firm’s projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm’s capital planning process, which incorporates risk management, internal controls, and governance practices that support the process.

This year, 18 of the largest and most complex banks were subject to both the quantitative and qualitative assessments. The 17 other firms in CCAR were subject only to the quantitative assessment. The Board may object to a capital plan based on quantitative or qualitative concerns.

The Board objected to the capital plan from DB USA Corporation due to qualitative concerns. Those concerns include material weaknesses in the firm’s data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress.

The Board issued a conditional non-objection to the capital plans of both Goldman Sachs and Morgan Stanley and both firms will maintain their capital distributions at the levels they paid in recent years, which will allow them to build capital over the next year. Each firm’s capital ratios, under the capital plans they originally submitted and with the one-time capital reduction from the tax law changes, fell below required levels when subjected to the hypothetical scenario. This one-time reduction does not reflect a firm’s performance under stress and firms can expect higher post-tax earnings going forward.

The Board also issued a conditional non-objection for the capital plan from State Street Corporation. The stress test revealed counterparty exposures that produced large losses under the hypothetical scenario, which assumes the default of a firm’s largest counterparty under stress. The firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Credit Suisse Holdings (USA); Discover Financial Services; Fifth Third Bancorp; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; RBC USA Holdco Corporation; Regions Financial Corporation; Santander Holdings USA, Inc.; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; UBS Americas Holdings LLC; and Wells Fargo & Company.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio–which compares high-quality capital to risk-weighted assets–of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.

Author

Ike Obudulu

Ike Obudulu

Versatile Certified Fraud Examiner, Chartered Accountant, Certified Internal Auditor with an MBA in Finance And Investments who has both worked for and consulted with some of the world's largest companies on main street and wall street in over 20 countries, Ike brings his extensive reporting and investigations experience to bear on his role as Chief Editor.
Phone
Email

Leave a Reply