Stress test results might jeopardize important profit source of Goldman Sachs

Goldman Sachs performed poorly compared to other big banks on the Federal Reserve stress tests last week.

Poor performance has raised concerns as analysts and investors worry that the bank could be barred by regulators from buying back its own stock or increasing dividends.

The multinational investment bank used dividends and share buybacks to appeal investors at a time when other elements of the bank’s business faced challenges.

When shares of their own stock on the open market are bought by the companies, it generally increases the amount of profits attributed to every share.

Now, given the results of the stress tests, analysts are concerned whether the Federal Reserve would allow Goldman to continue its buyback programs.

Brian Kleinhanzl, an analyst with Keefe, Bruyette & Woods, estimated that Goldman could earn 42 cents a share less than expected this year if it is unable to repurchase shares.

According to Mike Mayo, a bank analyst with CLSA, the stress tests could force Goldman to spend only $700 million on increased dividends and stock buybacks this year, in comparison with the $5.5 billion it spent on buybacks alone last year.

The day after the stress tests, shares of Goldman fell 1.7% while the broader bank sector was up. The bank’s trouble highlights how the Fed’s stress test can trip up even a bank like Goldman, which came out strongly out of the financial crisis.

The annual stress tests conducted by Federal Reserve are meant to ensure that banks have an adequate cushion to withstand losses if another financial crisis hits.

The Fed does not authorize the banks to give money back to shareholders when they have less of a cushion than they would need in severe crisis.

The final verdict on Goldman’s buyback plans will not be announced publically by the Fed until Wednesday.