Capital One must resubmit plan as 33 banks ace Fed tests

CAPITAL ONE FINANCIAL CORP. was the only one of the 34 major U.S. banks that underwent the annual Federal Reserve stress test that is being required to file a follow-up plan with the central bank. / BLOOMBERG NEWS FILE PHOTO/CRAIG WARGA
CAPITAL ONE FINANCIAL CORP. was the only one of the 34 major U.S. banks that underwent the annual Federal Reserve stress test that is being required to file a follow-up plan with the central bank. / BLOOMBERG NEWS FILE PHOTO/CRAIG WARGA

NEW YORK – Capital One Financial Corp. was alone among big U.S. banks in stumbling through the Federal Reserve’s annual stress tests, getting conditional approval to distribute capital to shareholders. Thirty-three other firms aced the review and are likely to pay out more than analysts had estimated.

The Fed ordered Capital One to shore up risk oversight to address “material weaknesses” and resubmit a plan for managing capital by Dec. 28. But broadly, banks subject to this year’s tests are expected to pay out close to 100 percent of their expected earnings over four quarters, substantially higher than the 65 percent last year, according to a senior Fed official.

It’s the first time all banks passed the tests since they started in the wake of the 2008 financial crisis, potentially opening the way for dividends to finally return to lofty levels last seen before that turmoil. Analysts had projected, on average, that banks might boost total payouts to 86 percent of earnings, according to figures gathered by Bloomberg. Shares of Citigroup Inc., for example, jumped in late trading after it announced plans to distribute as much as $18.9 billion in dividends and stock buybacks over four quarters – well over 100 percent of expected profits.

“Many firms continued to improve their capital planning practices,” the Fed wrote in a report detailing estimates for how they would perform during hypothetical economic shocks. That includes progress in how they make projections, measure risks and govern themselves, it said.

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“We are pleased to receive a positive CCAR result, with continued increasing return of capital to shareholders highlighted by a nearly 30% increase in our dividend next quarter and sizable share repurchases,” said Bruce Van Saun chairman and CEO of Citizens Financial Group Inc., one of the 33 banks that passed the stress test.“With strong capital levels relative to our peer group, we believe we are well positioned to continue to both invest in our growth initiatives and return capital to shareholders in order to drive enhanced shareholder returns.”

Capital One’s stumble was a surprise. Some analysts had opined that Wells Fargo & Co. might not pass after a retail account scandal exposed control lapses. And Morgan Stanley, which last year had to resubmit a plan for managing capital, trailed the rest of Wall Street on one of the main metrics during an initial round of testing last week. Both firms passed the final round Wednesday.

The Fed faulted how Capital One estimates the potential impact of “risks in one of its most material businesses,” the regulator said Wednesday in a statement, without specifying which business. Capital One draws the biggest share of its revenue from credit cards. The Fed said last week that the “recent uptick in delinquency rates in credit card portfolios” is among the stress points for banks being tested.

While the company can proceed with proposed payouts, the Fed said it might yet restrict those distributions if the resubmited plan doesn’t adequately address problems. Gatekeepers within the firm failed to discover the issues themselves, the Fed noted.

“The firm’s internal-controls functions, including independent risk management, did not identify these material weaknesses,” the regulator said. “Therefore, senior management was not in a position to provide the firm’s board of directors with a reliable assessment upon which to determine the reasonableness of the capital plan.”

Capital One’s board approved a $1.85 billion share repurchase program and the firm expects to maintain its quarterly dividend of 40 cents a share, according to a statement from the McLean, Va.-based company.

The company is “fully committed to addressing the Federal Reserve’s concerns with our capital planning process in a timely manner,” CEO Richard Fairbank said in the statement, noting that the company plans to update or affirm its guidance for full-year profits when it announces second-quarter earnings next month.

Wednesday’s results show that banks across the industry have more room to raise dividends after stockpiling capital in the wake of 2008’s financial crisis – but also after the Fed softened how aggressively it measures their ability to withstand severe shocks. This year, authorities dropped one of the toughest components, the so-called qualitative review, for all but the biggest banks.

The industry is counting on a further relaxation of rules as President Donald Trump appoints more business-friendly board members to the Fed, shifting the balance of power from regulators to shareholders. Earlier this month, Treasury Secretary Steven Mnuchin recommended that stress tests be performed every other year and that banks maintaining a sufficiently high level of capital be exempt from exams.

Broadly, “the Fed is going easy on the banks this time around when it comes to capital,” Nejat Seyhun, a finance professor at the University of Michigan in Ann Arbor, said before results were posted. “There is a new administration in town and Chairperson Janet Yellen is trying her best to get along with President Trump and push back on interference from the politicians against the Fed’s independence.”

Deutsche Bank AG’s New York-based trust bank and Banco Santander SA’s U.S. business, which had both failed two years in a row on qualitative standards, passed this year after being exempted from the qualitative exam. All of Frankfurt-based Deutsche Bank’s operations in the U.S. will be tested next year after the Fed required the largest foreign lenders to consolidate assets in the country under an umbrella structure starting last July. That will bring the German firm’s broker-dealer in the country under scrutiny for the first time in the tests.

“We provided the Federal Reserve with a comprehensive plan that reflects years of hard work around capital planning, liquidity management, stress testing, internal controls, governance and oversight,” said Santander Holdings USA CEO, Scott Powell. “Our strong capital position and improved risk management confirms that SHUSA is capable of withstanding extreme stress environments and is now in a position to begin returning capital to our parent company, Banco Santander.”

The annual review is a cornerstone of the Fed’s strategy to prevent a repeat of the 2008 financial crisis and taxpayer-funded bailouts. In an initial round last week, firms showed they have enough capital to handle hypothetical turmoil, such as surging unemployment, a sharp drop in housing prices or an extended stock slump. Wednesday’s results marked this year’s final round, determining whether they can withstand losses and still pay increased dividends and buy back more stock.

Capital One and American Express Co. were the only banks subject to this year’s tests that revised their capital plans after the first round. AmEx’s total risk-based capital was projected to fall below the required 8 percent minimum in the plan it originally submitted to the Fed.

Earlier this year, Capital One warned investors in a regulatory filing that it expects heightened oversight of its internal controls. As an example, it cited its obligation to monitor transactions for potential money laundering. The company entered into a consent order with the Office of the Comptroller of the Currency in 2015 to address concerns over that program, and “we have made substantial progress in taking the steps and making the improvements required,” the company wrote.

Yalman Onaran, Dakin Campbell and Jenny Surane are reporters for Bloomberg News.

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