2 Investment Banks That Could Raise Their Dividends Soon

Every year since the financial crisis, large publicly traded investment banks have had to take the Federal Reserve's stress tests. It's a cumbersome process, but the banks that pass it are typically then free to raise their dividends and increase the amount of shares they repurchase.

It's for this reason that investors can reasonably assume that Goldman Sachs (GS 0.22%) and Morgan Stanley (MS 0.44%) will soon boost their quarterly payouts. According to a recent analysis by KBW, Goldman and Morgan Stanley are expected to raise their annual dividends by $0.30 and $0.20 per share, respectively.

Data source: KBW.

Investors can be confident about predictions like these given Goldman Sachs and Morgan Stanley's performances on the first round of this year's stress tests, known as the Dodd-Frank Act stress tests, or DFAST.

The purpose of DFAST is to determine whether banks with more than $50 billion in assets on their balance sheets, otherwise known as systemically important financial institutions, have enough capital to survive a severe economic downturn akin to the 2008 crisis. The key threshold is a common equity tier 1 capital ratio, or CET1 ratio, of 4.5% -- the banks must exceed this through DFAST's nine-quarter time horizon.

Since the financial crisis, the Federal Reserve (its Washington, D.C. headquarters pictured here) has exercised veto power over big bank capital plans. Image source: Getty Images.

This wasn't a problem for either Goldman Sachs or Morgan Stanley. Goldman's CET1 ratio going into the test was 14.5%. That figure fell to a low of 8.4% at the nadir of the Fed's hypothetical gauntlet. Morgan Stanley's original ratio of 17.8% bottomed out at 9.4%. In both cases, then, even at their low points, Goldman Sachs and Morgan Stanley had upwards of twice as much high-quality capital as the regulators require.

Both banks are thus well positioned for the second round of the annual stress tests, known as the Comprehensive Capital Analysis and Review, the results of which are due out on Wednesday. It's in this stage that banks must request permission to increase how much capital they pay out to shareholders, through dividends and buybacks.

The Fed has denied bank dividend and buyback requests in the past, specifically in the cases of Bank of America and Citigroup, but there's little reason to think it'll do so this year for either of these banks, or when it comes to Goldman Sachs and Morgan Stanley. After seven years of stress testing, and an abundance of capital on their balance sheets, it would be surprising it these banks weren't soon given the go-ahead by regulators to pay out more capital to shareholders.