Most Banks Pass Stress Tests

Econintersect:  The Federal Reserve Board released the results of the annual stress tests of the 30 largest U.S. banks to assess how well each was prepared to weather either a moderate recession (adverse stress) or a severe recession (severely adverse stress).  Only one bank suffered an outright failure under the most adverse scenario stress, Zions Bank of Utah.

The most severe tests for 2014 were summarized by Sital S. Patel at MarketWatch:

This year’s “severely adverse” economic scenario will include these parameters: unemployment rate peaking at 11.25% in mid-2015, a decline in real U.S. GDP of nearly 4.75% through the end of 2014, as well as a 50% decline in equity prices and a 25% decline in home prices.

The Fed gave the following changes for the current stress tests from prior tests:

In addition to the 18 institutions that have been part of the stress tests since 2009, an additional 12 firms with assets greater than $50 billion were included this year;

The Federal Reserve used independent projections of balance sheet and risk-weighted asset growth rather than depending on the firms’ calculation for these categories as was done in prior years, improving the comparability and robustness of the results;

The tests included an estimate of losses that could result if a financial institution’s largest counterparty were to default unexpectedly. This scenario was applied to eight firms with substantial trading or custodial operations. The counterparty default scenario is part of the global trading shock, which is applied to six firms with large trading operations; and

The Federal Reserve in this year’s test began to phase in the revised capital framework approved by the Board in July 2013. The Federal Reserve calculated each firm’s capital ratios in accordance with the capital requirements that will be in effect during each projected quarter.

The following graphic from the Fed report summarizes the bank-by-bank results for the severely adverse stress test (with annotations added by Econintersect):

Sample Comments

• Moshe Orenbuch at Credit Suisse in New York (Financial Times):

“The tests should be thought of as less of a supervisory tool and more of a way to say who should and should not be allowed to distribute capital.”

• RBC Capital Markets banking analyst Gerard Cassidy (ABC News):

“The industry is stronger and more profitable than a year ago.”

• Paul Miller, an analyst at FBR Capital Markets (The Wall Street Journal):

“…the results bode well for banks’ approval of capital plans.  There’s nothing in here that I think is a big shocker.”

• Dan Ryan, head of PricewaterhouseCoopers LLP’s global financial regulation practice (Bloomberg), called the financial system safe:

“The average person who relies on the banking system should be happy.  Next week will tell us whether banks and bank shareholders will be happy.”

• Chris Kotowski, analyst at Oppenheimer (MarketWatch):

“In years past excess capital was hypothetical; this year it is absolutely a reality and with each passing CCAR, we think investors will regain more confidence.”

• Marc Saidenberg, former Fed director who is now a principal in Ernst & Young’s Financial Services Office (MarketWatch):

“This is the first time there are completely independent modeling of balance sheet and risk-weighted assets.  So that raises the potential to have a bigger difference in the bank’s model compared to the Fed’s model.”

Part Two Next Week

Next week a second phase of the Fed’s annual bank review will be released, as described in the Fed press release:

The quantitative results from both the adverse and the severely adverse scenarios in the supervisory stress tests are only one component in the Federal Reserve’s analysis during the Comprehensive Capital Analysis and Review (CCAR). CCAR is an annual exercise in which the Federal Reserve evaluates the capital planning processes and capital adequacy at the largest financial institutions. The latest CCAR results will be released on Wednesday, March 26, at 4 p.m. EDT. It is important to note that capital plans of firms in CCAR have been objected to on qualitative grounds even when capital ratios have exceeded all minimum post-stress capital requirements.

The upcoming report is the more important of the two with regard to bank management.  The capital planning actions of the banks at or below the 6% will be especially closely evaluated by the Fed.  Banks such as Ally, Bank of America, JP Morgan Chase, M&T and Morgan Stanley are likely to face tighter restrictions on distribution of capital (dividends, stock buybacks and compensation) than “healthier” banks.

Click on the cover image below to access the full report (pdf):

These tests are conducted annually under the authorization of the 2010 Dodd-Frank Act.

John Lounsbury

Sources:

• Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results (Board of Governors of the Federal Reserve System, March 2014, pdf)

• Press Release, Federal Reserve, 20 March 2014

• Bank stress tests to bring twists — and more dividends (Sital S. Patel, MarketWatch, The Wall Street Journal, 18 March 2013

• Fed stress tests find US banks could take big hit (Tom Braithwaite, Camilla Hall and Gina Chon, Financial Times, 20 March 2014)

• Nearly All Major US Banks Pass Fed ‘Stress Tests’ (Marcy Gordon and Alex Veiga, ABC News, 20 March 2014)

• Fed ‘Stress Test’ Results: 29 of 30 Big Banks Could Weather Big Shock (Ryan Tracy, Stephanie Armour and Dan Fitzpatrick, The Wall Street Journal, 20 March 2014)

• Stress Test Shows 29 of 30 Banks Meet or Top Capital Target (Craig Torres and Michelle Jamrisko, Bloomberg, 20 March 2014)