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U.S. banks expect a clean bill of health after Fed’s stress tests

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© Reuters. FILE PHOTO: An eagle tops the U.S. Federal Reserve building’s facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst/File Photo

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By Pete Schroeder

WASHINGTON (Reuters) – Large U.S. banks are optimistic they will receive a clean bill of health from the Federal Reserve this week, freeing them up to distribute billions of dollars in excess capital to investors.

The central bank on Thursday will release the results of its annual bank “stress tests” which assess how much capital banks would need to withstand a severe economic downturn.

The annual exercise, introduced following the 2007-2009 financial crisis, is integral to banks’ capital planning, dictating how much cash they can return to shareholders in the form of dividends and share buybacks.

Analysts and executives say lenders are well-positioned for the 2022 test, as the economic stresses of the COVID-19 pandemic fade and lenders become more adept at navigating the exam.

“All should pass,” analysts at Barclays (LON:BARC) wrote in a note on Thursday. “We also expect almost every bank involved to hike its dividend this year and next.”

Banks have performed well in tests in recent years, which included supplemental exams introduced amid the pandemic-induced economic turmoil. Last year, the Fed found banks would suffer a combined $474 billion in losses in a severe downturn, but that would still leave them with more than twice as much capital required under Fed rules.

Still, analysts expect this year’s test to be tougher than the 2021 exercise and for bank buffers to be slightly higher as a result.

That’s because the test gets harder as the real economy grows stronger, while banks have also shrunk cushions they had put aside for pandemic losses which did not materialize. This year, the Fed’s “severely adverse” scenario envisages the unemployment rate jumping 5.75 percentage points, compared with 4 percentage points in 2021.

How well a bank performs dictates the size of its “stress capital buffer” – an extra cushion of capital the Fed requires for banks to weather the hypothetical economic downturn, on top of regulatory minimums required to support daily business.

The larger the losses under the test, the larger the buffer.

Credit Suisse analysts project on average that buffer will be 3.3%, compared with 3.2% last year.

“There may be more stress, but there ought to be ample excess capital to render this manageable,” they wrote.

NO SURPRISES EXPECTED

Top bank executives struck a relaxed tone on the tests during a New York conference hosted by Morgan Stanley (NYSE:MS) last week.

“It’s possible our stress capital buffer goes up, given the scenario that we had to deal with. And we’re well positioned to deal with it,” Wells Fargo (NYSE:WFC) & Co. chief financial officer Mike Santomassimo told investors and analysts.

Speaking at the same event, Morgan Stanley chief executive James Gorman said he’d be “surprised” if the bank’s capital numbers were “meaningfully different.”

That equanimity may not last. This year’s test is relatively straight-forward partly because the Fed has not had a Vice Chair for Supervision since Randal Quarles stepped down last year.

Appointed by former U.S. President Donald Trump, a Republican, Quarles streamlined the stress test process in response to industry gripes that it was often opaque and subjective.

Many analysts expect the Fed to revisit those changes once Michael Barr, Democratic President Joe Biden’s nominee to replace Quarles, is confirmed by the Senate.

Barr could restore a requirement that banks must pre-fund nine quarters of expected dividend payments as part of their capital planning, which Quarles had trimmed to four quarters.

He could also undo steps Quarles took to make the tests more predictable, such as providing more information about the Fed’s models and scrapping the central bank’s ability to flunk lenders on subjective concerns, such as risk management lapses.

“We expect Biden’s Fed picks will work next year to toughen” the test, wrote Jaret Seiberg, an analyst with Cowen Washington Research Group.

Stock Markets

Russia in historic default as Ukraine sanctions cut off payments

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© Reuters. FILE PHOTO: The clock on Spasskaya tower showing the time at noon, is pictured next to Moscow?s Kremlin, and St. Basil?s Cathedral, March 31, 2020. REUTERS/Maxim Shemetov

By Karin Strohecker, Andrea Shalal and Emily Chan

LONDON/NEW YORK (Reuters) -Russia defaulted on its international bonds for the first time in more than a century, the White House and Moody’s (NYSE:MCO) credit agency said, as sweeping sanctions have effectively cut the country off from the global financial system, rendering its assets untouchable.

The Kremlin, which has the money to make payments thanks to oil and gas revenues, has rejected the claims, and accused the West of driving it into an artificial default.

Earlier, some bondholders said they had not received overdue interest on Monday following the expiry of a key payment deadline on Sunday.

Moody’s credit agency later on Monday said that the missed coupon payment constituted a default.

“Further defaults on coupon payments are likely,” Moody’s analysts wrote.

Russia has struggled to keep up payments on $40 billion of outstanding bonds since its invasion of Ukraine on Feb. 24.

“This morning’s news around the finding of Russia’s default, for the first time in more than a century, situates just how strong the actions are that the U.S., along with allies and partners, have taken, as well as how dramatic the impact has been on Russia’s economy,” the U.S. official said on the sidelines of a G7 summit in Germany, which U.S. President Joe Biden is attending.

Russia’s efforts to avoid what is its first major default on international bonds since the Bolshevik revolution more than a century ago hit a roadblock in late May when the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) effectively blocked Moscow from making payments.

A formal default would be largely symbolic given Russia cannot borrow internationally at the moment and doesn’t need to thanks to plentiful oil and gas export revenues. But the stigma would probably raise its borrowing costs in future.

“With Russia going into sovereign default the international community has moved into a new, more aggressive phase of its sanctions campaign against Moscow,” said Adam M. Smith, partner at Gibson Dunn in Washington.

The payments in question are $100 million in interest on two bonds, one denominated in U.S. dollars and another in euros, that Russia was due to pay on May 27. The payments had a grace period of 30 days, which expired on Sunday.

“Russia’s default – already determined by the failure to pay interest last month – had been largely priced in and bonds have been in the 10-20 cents area for a long time,” said Gabriele Foa, portfolio manager of the Global Credit Opportunities Fund at Algebris. “I do not expect creditors to organize and hold talks for a restructuring soon, as these talks are likely not possible amid political tensions.”

Russia’s finance ministry said it made the payments to its onshore National Settlement Depository (NSD) in euros and dollars, adding it had fulfilled obligations.

In a call with reporters, Kremlin spokesperson Dmitry Peskov said the fact that payments had been blocked by clearing house Euroclear because of Western sanctions on Russia was “not our problem”.

Euroclear did not respond to a request for comment.

Some Taiwanese holders of the bonds had not received payments on Monday, sources told Reuters.

With no exact deadline specified in the prospectus, lawyers say Russia might have until the end of the following business day to pay these bondholders.

Credit ratings agencies usually formally downgrade a country’s credit rating to reflect default, but this does not apply in the case of Russia as most agencies no longer rate the country.

“I think the market convention will be that it is a default – though the technical issues are rather complex,” said Kaan Nazli, portfolio manager at Neuberger Berman, which has a small exposure to Russian sovereign debt but does not hold the bonds that were due a payment on May 27. “It is a somewhat politically driven default.”

Emerging markets trade group EMTA recommended on Monday that bonds issued by the Russian government should be traded without accrued interest, the way bonds in default are typically traded.

LEGAL TANGLE

The legal situation surrounding the bonds looks complex.

Russia’s bonds have been issued with an unusual variety of terms, and an increasing level of ambiguities for those sold more recently, when Moscow was already facing sanctions over its annexation of Crimea in 2014 and a poisoning incident in Britain in 2018.

Rodrigo Olivares-Caminal, chair in banking and finance law at Queen Mary University in London, said clarity was needed on what constituted a discharge for Russia on its obligation, or the difference between receiving and recovering payments.

“All these issues are subject to interpretation by a court of law,” Olivares-Caminal told Reuters.

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Stock Markets

TSX climbs to 2-week high as resource shares rally

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© Reuters. FILE PHOTO: The Art Deco facade of the original Toronto Stock Exchange building is seen on Bay Street in Toronto, Ontario, Canada January 23, 2019. REUTERS/Chris Helgren/File Photo

By Fergal Smith

TORONTO (Reuters) – Canada’s main stock index rose on Monday to its highest level in nearly two weeks, aided by gains in resource-linked shares and an upbeat mood in global equities, although Bombardier (OTC:BDRBF) Inc tumbled to its lowest in 15 months.

The Toronto Stock Exchange’s S&P/TSX composite index ended up 195.41 points, or 1%, at 19,258.32, its highest closing level since June 15.

Meanwhile, global markets held on to Friday’s rally as the recent pullback in commodity prices tempered concerns of prolonged inflation.

Investors have worried that aggressive central bank interest rate hikes to cool inflation could derail economic growth.

“Today’s pick up in risk appetite is simply that maybe rates will not be hiked as far as thought previously,” said Stuart Cole, head macro economist at Equiti Capital.

“There is also talk about a rebalancing by large institutional investors taking place as we reach end H1, moving back into stocks on the back of this perceived brighter outlook and reduced worry about recession.”

Canada’s commodity-linked market is on track to fall 12% in the second quarter, which would be its biggest decline since the first quarter of 2020.

The energy sector rallied 4.7% on Monday as oil prices rose. U.S. crude oil futures settled 1.8% higher at $109.57 a barrel as the Group of Seven nations promised to tighten the squeeze on Russian President Vladimir Putin’s war chest while actually lowering energy prices.

The materials group, which includes precious and base metals miners and fertilizer companies, added 2%, while heavily-weighted financials ended 0.7% higher.

Shares of business jet company Bombardier tumbled 17.3% to hit their lowest since March 2021.

A former Garuda Indonesia chief convicted of graft is being investigated for alleged irregularities in procuring Bombardier and ATR planes, Indonesia’s attorney general said.

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Stock Markets

Morgan Stanley Announces 11% Dividend Hike and $20B Buyback Following Stress Test

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© Reuters. Morgan Stanley (MS) Announces 11% Dividend Hike and $20B Buyback Following Stress Test

By Davit Kirakosyan

Following the results of the 2022 stress test, Morgan Stanley (NYSE:MS) announced it will increase the quarterly dividend on its common stock 11% to $0.775 from the current $0.70 per share.

Furthermore, the company’s Board of Directors authorized a new multi-year common equity share repurchase program of up to $20 billion, beginning Q3/22.

CEO James Gorman commented, “We are pleased to continue our robust capital return program, which is driven by our business transformation, especially the durable earnings from our Wealth Management and Investment Management businesses. After doubling our dividend last year, we are raising our dividend 11% and continuing to buy our stock under a new $20 billion multi-year share repurchase authorization. The strength and stability of our franchise and our capital cushion provide us the flexibility to continue to invest for future growth while also returning capital to shareholders.”

The company’s shares were trading 1.50% higher after-hours following the news.

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