By Peter Rudegeair and Jeannette Neumann 

The Federal Reserve rejected the capital plan of Santander Holdings USA Inc. in the regulator's annual stress test released Wednesday.

This marks the third consecutive year in which the Fed faulted the U.S. unit of Spain's Banco Santander SA in its yearly review. Although the U.S. central bank found that the unit had enough capital to weather a severe economic downturn, it rejected Santander's capital plan for so-called qualitative reasons, citing "material unresolved supervisory issues."

Among the deficiencies the Fed identified at Santander were weaknesses in "internal controls, governance, and oversight functions" as well as problems measuring and monitoring risk.

Santander executives have said during the past couple of years that the regulatory troubles in the U.S. are partially the result of growing pains as the lender builds up from scratch a holding company to oversee its banking unit and consumer-lending subsidiary.

At the low point of a hypothetical recession, Santander's common equity Tier 1 ratio -- which measures high-quality capital as a share of risk-weighted assets -- were estimated at 11.9%, well 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.

Santander's Tier 1 leverage ratio, which measures high-quality capital as a share of all assets, would have reached as low as 10.1% in a hypothetical recession according to the regulator's calculation, well 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 results 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.

Santander's rejected capital plan is the latest in a string of setbacks in the U.S. Last July, the Fed faulted the bank's U.S. unit for failing to meet regulators' standards on a range of basic business operations.

At the end of February, Santander revealed that executives at the consumer-lending unit, a major issuer of risky car loans in the U.S., had delayed the filing of its annual report after the U.S. Securities and Exchange Commission raised questions about how it provisions for loans.

"It is just a clarification we are working on with the SEC," Santander Chief Financial Officer Jose Garcia Cantera said in an interview at the time.

Santander Consumer USA Holdings Inc. eventually published its annual report at the end of March.

The company said in the filing that its "CEO and CFO have concluded that as of December 31, 2015, we did not maintain effective disclosure controls and procedures," citing problems with how it estimates provisions for loan losses; ineffective oversight of the inputs and assumptions used in its models and a badly-managed hiring process that left the company with poorly-trained and ill-experienced financial staff.

"We are currently working to develop plans to remediate the material weaknesses," the company added in the March 31 filing.

Write to Peter Rudegeair at Peter.Rudegeair@wsj.com and Jeannette Neumann at jeannette.neumann@wsj.com

 

(END) Dow Jones Newswires

June 29, 2016 16:45 ET (20:45 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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