What happened
Shares of Goldman Sachs (NYSE: GS) had risen nearly 5.4% as of 12:25 p.m. ET today after the Federal Reserve released its annual stress-testing results last night. Goldman Sachs performed well in the test.
So what
Every year, the largest U.S. banks are put through a hypothetical economic scenario that is extremely severe so the Fed can see how banks would perform in order to ensure the safety and soundness of the banking system. The Fed also uses stress testing to help set minimum capital requirements for banks, and these determine how much capital banks can return to shareholders.
In this year's scenario, the Fed had unemployment surpassing 10%, commercial real estate prices falling 40%, and stock prices dropping 55% between the fourth quarter of 2021 and the first quarter of 2024.
During this time, Goldman Sachs would see its common equity tier 1 (CET1) capital ratio, a measure of a bank's core capital expressed as a percentage of its risk-weighted assets such as loans, fall from 14.2% to 8.4%.
The Fed also estimates that Goldman would incur about $18.3 billion of loan losses and end up taking a $12.7 billion pre-tax loss over the nine quarters.
Now what
Jefferies analyst Ken Usdin called Goldman a "relative winner" from the testing, largely due to its capital results.
The results could lead to a decline in Goldman's CET1 ratio requirements from the Fed. Currently, Goldman's required CET1 is 13.4%.
Goldman has previously said that it wants to operate the firm at a 13% to 13.5% CET1 ratio, which means it needs its required CET1 by the Fed to be lower, likely around 13% if it wants to manage the bank at 13.5%.
The stress testing results could lead to a lower required CET1 ratio for Goldman, which the bank will likely disclose more information about on Monday. Lower capital ratios usually mean higher capital returns for shareholders.
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs and Jefferies Financial Group Inc. The Motley Fool has a disclosure policy.
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