Morgan Stanley, Goldman Got Help From Fed on Stress Tests

Federal Reserve officials told Goldman Sachs Group Inc. GS -0.72% and Morgan StanleyMS -0.56% that they were about to flunk a portion of the annual stress tests but offered them a deal to avoid an outright fail and continue paying billions to shareholders.

.. regulators told them that to fully pass the test, they would have to cut almost in half the combined $16 billion they had hoped to pay out to shareholders

.. Fed officials gave the banks an unprecedented option: If they agreed to freeze their payouts at recent levels, they would get a “conditional non-objection” grade and avoid the black eye of failure. That meant the banks could pay out a combined $13 billion, or about $5 billion more than what they would have given back to investors if they had decided to retake the test and get a passing grade.

It also will boost a profitability measure that helps determine how much Goldman Chief Executive Lloyd Blankfein and Morgan Stanley CEO James Gorman are paid.

.. The arrangement is the first of its kind in the eight years of the Fed’s annual tests, and one of the clearest signs to date of a significant shift in the regulatory environment for banks, which have been expecting a gentler approach from Washington ever since the election of President Donald Trump.

New refs, new rules,” consulting firm PricewaterhouseCoopers LLP wrote in a note.

This round of tests was the first graded by Trump appointee Randal Quarles, a former Wall Street lawyer and private-equity executive who last year became the Fed’s regulatory czar.

.. “This year’s stress test followed the same notification process as in past years—all firms were notified of the results and given the fixed option to reduce their capital payout plans with no negotiations,” a Fed spokesman said.

.. Fed officials said their leniency toward Goldman and Morgan Stanley was due in part to the impact of the 2017 tax law, which reduced the value of certain tax assets held by the banks and meant they entered the crisis scenario with diminished capital reserves

.. The stress tests, arguably the most visible sign of the postcrisis crackdown on Wall Street, are being changed in ways that benefit the industry. The Fed exempted three firms with less than $100 billion of assets from the test this year under the new banking law. Its treatment of Morgan Stanley and Goldman—as well as State Street Corp. , which got a pass although it also failed to clear capital requirements under the stress scenario—showed the Fed taking a more flexible approach to what had been a binary exercise.

“The Fed was very kind,” said Arthur Angulo, a managing director at Promontory Financial Group and a former Fed official. He added the Fed’s exercise of discretion on the quantitative portion of the test was “a potential slippery slope.”

.. The interim director at the Consumer Financial Protection Bureau, Mick Mulvaney, has largely stopped initiating new investigations and wants the consumer-finance regulator to be less antagonistic to the businesses it regulates.

.. If Goldman had been required to rejigger its plan until its capital ratios exceeded the Fed’s minimum, the bank would have been able to seek just over $1 billion in buybacks, instead of the $5 billion that was approved