MS Morgan Stanley

By Liz Hoffman 

The Federal Reserve conditionally approved Morgan Stanley's capital plan in the bank regulator's annual "stress test" Wednesday but said the firm would have to resubmit its plan later this year to address shortcomings in its process.

Morgan Stanley's plan was approved after the Fed found the bank could keep lending in a severe economic downturn even while increasing its dividend and buying back stock. The approval clears the way for the firm to reward investors by returning more capital.

But the Fed didn't give Morgan Stanley a clean pass. Rather, the firm received a "conditional non-objection" after the Fed said it "exhibited material weaknesses in its capital planning process" and failed to adequately account for certain vulnerabilities in a downturn. The Fed said Morgan Stanley must resubmit its plan by Dec. 29.

Morgan Stanley is the only one of the big U.S. banks not to sail through the test. Last year, Bank of America Corp. received a similar result on its 2015 stress test.

At the low point of a hypothetical recession, the Fed calculated Morgan Stanley's common equity Tier 1 ratio -- which measures high-quality capital as a share of risk-weighted assets -- would be 7.7%, above the 4.5% level the Fed views as a minimum. The new ratio, unlike the one reported last week by the Fed in a related test, takes into account the bank's proposed capital plan.

Morgan Stanley's Tier 1 leverage ratio, which measures high-quality capital as a share of all assets, would have reached as low as 4.5% in a hypothetical recession, above the 4% Fed minimum.

The latest stress-test result incorporates quantitative factors assessed in data released by the Fed last week. These included a simulation of how the bank's capital buffers would hold up under a world-wide recession. The Fed's "severely adverse" scenario of financial stress this year included a 10% U.S. unemployment rate, significant losses in corporate and commercial real estate lending portfolios, and negative rates on short-term U.S. Treasury securities.

This second part of the test also included a qualitative assessment by the Fed of a bank's capital-planning process and internal controls. The Fed has the ability to object to a bank's capital plan on either quantitative or qualitative grounds.

The Fed's Wednesday findings are arguably the more important part of the stress-test process since they dictate how much capital will be returned to shareholders. Increased dividends and buybacks can help to bolster a bank's share price.

Morgan Stanley has been slower to recover from the financial crisis than some of its peers, reflected by its smaller dividend and more gradual buyback ramp-up. Morgan Stanley Chairman and Chief Executive James Gorman has worked to make the firm more stable by adding to the firm's wealth management business.

After taking the so-called "mulligan" last year -- the term for occasions when a bank's first submitted capital plan doesn't pass muster with regulators -- Morgan Stanley's revised plan was approved. The firm raised its quarterly dividend to 15 cents from 10 cents and increased its buyback program.

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

June 29, 2016 16:44 ET (20:44 GMT)

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