CHICAGO--(BUSINESS WIRE)--The first round of this year's Fed-supervised bank stress tests highlights the relative resilience of U.S. regional and custody banks in a severe economic stress scenario. The largest trading and universal banks, on the other hand, will likely face constraints in pursuing more aggressive capital distribution plans in part because of severe market shock assumptions employed in the tests, according to Fitch.
The Fed-administered tests, which analyze the ability of 18 large U.S. financial institutions to absorb severe economic and market pressure in a hypothetical adverse scenario, support the view that most banks' capital and liquidity positions are sufficiently strong to incur heavy losses in their loan and trading books over a prolonged period (nine quarters). Of the institutions reviewed, only Ally Financial failed to maintain a Tier 1 capital ratio above 5%, after stresses were applied through the end of 2014.
Importantly, the first review assumes that all institutions maintain dividends at existing levels and that no additional capital actions (dividend increases or share repurchases) take place.
Related results from the Comprehensive Capital Adequacy Review (CCAR) tests, which factor in banks' planned capital actions, will be released on March 14. Based on the results of the first round of Dodd-Frank tests, we expect all institutions except Ally to meet the Fed's minimum capital requirements for the CCAR. This is supported by the fact that banks are able to resubmit their capital plans after reviewing first-round results.
Large regional and custodial banks saw less significant declines in projected Tier 1 capital ratios by year-end 2014 under the severely adverse scenario. Regional institutions, including BB&T, PNC, US Bancorp and Fifth Third, all maintained capital ratios above 7% at the end of 2014 under the severe stress assumptions. Custodial banks, including State Street and Bank of New York Mellon, fared best among all institutions in terms of capital levels and projected losses.
The relative strength of these institutions reflects the smaller size of their trading operations and what appears to be relatively harsh market risk scenarios applied to the trading and derivative books of the largest U.S. institutions.
We believe the projected risk-based capital ratios for the largest trading banks were affected significantly by the much higher risk-weighted assets assumed under the Market Risk Capital Rule implemented Jan. 1, 2013. Therefore regulatory capital ratios under DFAST are not directly comparable to last year's test for the largest institutions -- JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley -- due to the significantly higher risk weightings.
The big six banks also faced a heavier burden as a result of the time horizon and scope of the global market shock used in the severely adverse case. The global market stress was applied early in the testing horizon, imposing larger losses on trading banks and magnifying declines in capital relative to the other banks. Trading, private equity and derivative positions of the big six banks were subject to this instantaneous shock.
For the most part, projected trading and counterparty losses for the big six banks under the Fed's test were not significantly different from the banks' own estimates, provided separately. As an example, Goldman Sachs's estimate of $23.3 billion in losses by the end of 2014 was only modestly lower than the stress test result of $24.9 billion.
Citigroup fared significantly better in this year's stress test relative to 2012. Following the release of test results, the bank has already announced its request to repurchase $1.2 billion in shares, aimed at offsetting dilution. Citi has no plans to increase its dividend payout.
Stresses applied in the tests appeared quite onerous. The severely adverse scenario assumes a sharp economic contraction beginning in 2013, with the U.S. unemployment rate rising by four percentage points to almost 12%. Residential and commercial real estate prices are assumed to fall by almost 20% by year-end 2014, and equity prices are assumed to fall by 50% from late-2012 levels.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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