Fed Rebukes Goldman Sachs and JPMorgan Chase Over Capital Plans

Goldman Sachs and JPMorgan Chase, the Wall Street giants that emerged from the financial crisis in a position of strength, are now facing questions about their ability to withstand future market shocks.

On Thursday, the Federal Reserve said Goldman and JPMorgan would need to resubmit their proposals to pay out billions of dollars to shareholders, citing weaknesses in their capital plans. In the meantime, the banks can move ahead with their shareholder payouts.

In contrast, two of the nation’s most troubled banks during the crisis, Citigroup and Bank of America, got an unconditional green light from regulators for their plans to reward shareholders.

The Fed’s rebuke to Goldman and JPMorgan highlights growing tension as regulators try to make sure banks are better prepared for the next market shock. With profits improving, financial institutions want to enrich investors by increasing dividends and buying back shares. But regulators want banks to be cautious with their capital, in case of future losses.

Regulators are trying to prevent a repeat of 2008, when the banking industry brought the financial system to the brink and many institutions had to be bailed out by taxpayers. To guard against potential problems, Congress mandated that regulators annually test the financial strength of large banks. As part of that effort, regulators can now stop banks from paying out capital, which lenders could previously do with little oversight.

Last week, the Fed released the results of this year’s so-called stress tests, which assess the ability of the banks to deal with severe financial and economic shocks. While the test showed that banks had substantially increased their capital levels since the financial crisis, JPMorgan and Goldman Sachs lagged many of their peers.

Even so, analysts expected JPMorgan and Goldman to gain outright approval for their plans to distribute capital to shareholders through dividend payments and stock buy backs. Both banks have generated solid profits since the crisis, though JPMorgan stumbled badly last year when it suffered big trading losses.

While the Fed has allowed JPMorgan and Goldman to move forward with their capital plans, the regulators said the proposals “exhibited weaknesses” that were “significant enough to require immediate attention.” The banks will now have to address the shortcomings and resubmit them by the end of September. If they aren’t fixed by then, the Fed may block their capital plans.

“JPMorgan is the loser in all of this,” said Paul Miller, a bank analyst at FBR. “Even though the bank got everything it wanted, it does now have to file another plan.”

Currently, JPMorgan plans to increase its dividend to 38 cents a share in the second quarter of 2013, up from the expected payout of 30 cents in the first quarter. The board also outlined plans to repurchase up to $6 billion of stock through early 2014.

“JPMorgan Chase is fully committed to meeting all of the Fed’s requirements,” the bank’s chief executive, Jamie Dimon, said in a statement. In a statement, Goldman said it intended to “resubmit its capital plan by the end of the third quarter, incorporating certain enhancements to its stress test processes.”

The Fed turned down the capital plans proposed by Ally Financial and BB&T, two smaller banks. Ally failed the latest stress test. While BB&T’s capital levels appeared healthy, the Fed found flaws with the data for the bank’s assets.

For Bank of America and Citigroup, the Fed’s approval is an important milestone in their efforts to heal themselves. The Fed in previous years objected to their plans, an embarrassing black eye for both firms.

With the Fed’s blessing, Citigroup disclosed plans to buy back $1.2 billion of stock. On Thursday, Bank of America, the nation’s second-largest bank by assets, immediately announced its intention to buy back $5 billion of common stock and pay out $5.5 billion to redeem preferred shares.

“Bank of America was by far the biggest winner this year,” said Todd L. Hagerman, a bank analyst at Sterne Agee. “It’s a true testament to the restructuring at that company that it’s finally receiving the Fed’s gold star.”

Bank of America, in particular, has been dogged by costly mortgage litigation stemming from the housing crisis. Mr. Miller, the analyst, said that the approval of Bank of America’s capital plan suggested that the mortgage liabilities did not concern the Fed that much.

While both banks are pursuing stock repurchases, neither Citigroup nor Bank of America decided to increase their dividends from a penny a share each quarter. The decision reflects the continuing challenges for the industry, which has been hampered by a sluggish economy and new regulation.

Buyback plans give the banks more flexibility, allowing them to halt their plans if the environment deteriorates. Dividends, on the other hand, require banks to pay out a set amount of cash each quarter.

JPMorgan and Goldman, which will be able to make their capital distributions, have the headache of getting their plans up to the Fed’s standards.

When producing their proposals, large banks now have to forecast how much capital would be eaten away by losses in hypothetical economic and market turbulence. In the case of JPMorgan and Goldman, the Fed had some concerns about the banks’ forecasts for losses and revenues in a crisis scenario, according to a senior official at the Fed.

Last week, the Fed released its calculations based on the stress tests, and the banks came up with their own results, based on identical scenarios. On certain estimates, JPMorgan and Goldman differed significantly from the Fed. Other banks diverged as well.

The Fed’s refusal to approve Ally’s plan will intensify questions about the lender, which is majority owned by the government after a taxpayer bailout. Its first capital plan submitted in January did not pass muster with the Fed, but it also did not get approval for a second, revised one. In a statement, Ally said it disagreed with the Fed’s analysis. “Ally Bank continues to be a well-capitalized bank with a leading position in the market,” the statement said.

On the face of it, BB&T had a comparatively strong showing in the stress tests, but last week the Fed noted that there were problems with the data submitted by the regional bank. BB&T said on Thursday in a statement that it did not believe that the Fed’s objections to its plan were related to its “capital strength, earnings power or financial condition.” It said the Fed did not object to the bank continuing to pay its first quarter dividend, 23 cents a share, in coming quarters.

American Express’s initial capital plan did not appear to satisfy the Fed. The financial firm recently resubmitted its plan, which was approved. But, to do so, American Express had to scale down its buyback plans by $1.5 billion.

Despite the improving capital levels, some banking specialists said it was too early to allow banks to make large pay outs because some capital measurements were not yet high enough. One of those yardsticks is the so-called leverage ratio, which takes a simpler and more conservative approach to assessing capital than other metrics.

“I would like to see these leverage ratios much stronger before they distribute capital,” said Sheila C. Bair, former chairwoman of the Federal Deposit Insurance Corporation, a banking regulator. But she added, “The positive side is that they’re getting more information out about the megabanks.”