After the Federal Reserve made new capital requirements for big banks official on Aug. 10, Goldman Sachs Group Inc. continues to stand out as the only firm to fall short as of its most recent financial report.
The new requirements are due to go into effect for the year starting Oct. 1 and incorporate hypothetical stress test losses formally into required capital ratios. In previous years, the stress tests were a separate exercise, but they imposed roughly similar constraints on capital levels.
The requirements the Fed published are in line with what banks said the central bank told them they would be in individual disclosures in late June. Many banks reported capital well in excess of the forthcoming requirements in recent periods, including PNC Financial Services Group Inc., whose Tier 1 common equity at June 30 exceeded its requirement by 61%. PNC has said the proceeds from the sale of its stake in BlackRock Inc. in May could serve as a war chest for a major bank acquisition, if fallout from the recession shakes loose the right opportunity. CET1 at PNC's peers U.S. Bancorp and Truist Financial Corp. exceeded their requirements by 29% and 35%, respectively.
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But with the deep recession caused by the coronavirus pandemic, and with the Fed stress tests scheduled to extend into a second review of capital plans later this year after regulators release new hypothetical downside scenarios, most banks have been focused more on demonstrating that they could withstand severe losses, rather than making the case for big shareholder payouts in the near term. Moreover, the Fed has temporarily prohibited share repurchases and capped dividends based on recent earnings, which have been sapped by giant credit loss provisions.
With blowout trading results in the second quarter, Goldman made progress toward its 13.7% common equity Tier 1 ratio requirement, with its ratio under the standardized approach increasing to 13.3% at June 30 from 12.5% at March 31. That includes charges related to its $3.9 billion settlement with Malaysia over its involvement in the 1MDB affair.
When Goldman disclosed its new CET1 requirement, Chairman and CEO David Solomon said the company has "a track record of rebuilding capital when necessary." Based in part on the revenue momentum it has shown, which implies an ability to use earnings to build capital, markets appear to be giving Goldman the benefit of the doubt. Analyst share price targets for the company have moved up appreciably since it reported second-quarter earnings in July.
In a note in August, Keefe Bruyette & Woods analyst Brian Kleinhanzl raised his earnings forecasts for Goldman mostly because investment banking and trading revenues do not appear to be dropping off as much as expected as markets stabilize after a tumultuous second quarter. He said the bank "is largely done resolving 1MDB issues and management should be able to address the other major overhang," the new capital requirement.
Reducing "capital intensity" by shedding riskier investments and building up more stable streams of income — financing and managing assets for other investors instead of direct ownership, for example — is a major strategic goal for Goldman.
In a conference call on second-quarter results, CFO Stephen Scherr said the new capital requirement for Goldman "is higher than anticipated," but the bank is proceeding with the sale of billions of dollars of equity holdings, including exiting its position in Global Atlantic Financial Group Ltd., an annuity writer and reinsurer Goldman formed in 2004.
The bank's risk-weighted assets also dropped 5.3% sequentially in the second quarter, compared with a drop of 5.5% at Bank of America Corp. and a drop of 3.6% at JPMorgan Chase & Co. Scherr said the bank had been able to handle surging trading volumes without building up an "elevated inventory" of securities, and it remains committed to its medium-term target for its CET1 ratio of 13% to 13.5%.
Scherr also said Goldman has been "very active" in pressing the case with the Fed that its trading revenue has done well during periods of high volatility, even though severe trading losses are a big component of the decline in its capital contemplated in regulatory stress tests.
In its Aug. 10 announcement, the Fed said it had affirmed its stress test results for Goldman and four other banks that had asked regulators to reconsider them.
Citizens Financial Group Inc. had argued that the Fed had failed to take into account loss-sharing agreements and other factors, resulting in credit cost estimates that were too high, and that the Fed underestimated its earnings power because it incorporated historical data from when it was owned by what was then Royal Bank of Scotland Group PLC and "was forced to severely reduce the size of its balance sheet" because of problems at its parent during the last crisis.
Regions Financial Corp. argued that the Fed underestimated its earnings because it failed to fully account for the impact of its interest rate hedges.
Capital One Financial Corp., which cut its dividend along with Wells Fargo & Co. because of the Fed's restriction based on net income, had also asked regulators to reconsider its capital requirement.