All 33 US banks that underwent regulatory stress tests this year were able to withstand severe economic and market conditions while staying above minimum required capital levels, the US Federal Reserve said on Thursday. Overall, big banks would suffer $385 billion in loan losses over a period of nine quarters under the most severe scenario, the Fed said. A key capital ratio measuring Tier 1 common equity as a portion of risk-weighted assets would drop to a low of 8.4 percent, in aggregate - well above the minimum set by regulators.
However, the results released on Thursday - part of a test known as "DFAST" - only offer a glance of big banks' capital pictures under stress. On June 29, the Fed will release results of a more comprehensive test, known as "CCAR," which will include whether or not banks can buy back as much stock and pay out as many dividends as they had planned. "DFAST is sort of like a dress rehearsal for the CCAR," said Ernie Patrikis, a partner at the White & Case law firm and a former bank regulatory official at the Federal Reserve Bank of New York.
DFAST, short for the Dodd-Frank Act Stress Test, is part of the sweeping financial reform law passed in the wake of the 2007-2009 financial crisis. It relies on standardised assumptions about capital levels and distributions for the tested banks, allowing for a consistent view across the industry.
The Fed does not pass or fail banks in this stage of testing, but they can fail "CCAR," which is short for Comprehensive Capital Analysis and Review. That test evaluates banks' individually tailored plans for surviving a crisis. Regulators view both rounds as tools to ensure banks have enough money to stand on their own in a future financial crisis and not turn to the federal government for billions of dollars in bailouts.
Of the 33 banks that took part in DFAST, Huntington Bancshares Inc produced the lowest minimum Tier 1 common equity ratio, of 5 percent, under a severely adverse scenario. Morgan Stanley produced the weakest Tier 1 leverage ratio - another measure of capital strength relative to assets - of 4.9 percent, under that scenario.
Banks that look marginal in DFAST may well have submitted capital plans that include the issuance of securities that would dramatically affect their capital scores. And, banks with strong numbers can still fail CCAR because the Fed judged the quality of their capital planning faulty. Citigroup Inc, for example, has had surprising results for both reasons. In last year's DFAST scores, Citigroup looked like it was at risk of failing when one measure of its capital came up barely above that minimum. But, unknown to investors, Citigroup's capital plan included steps that significantly improved its measure of strength.
In 2014, Citigroup's numbers were good, but the Fed rejected its plan after concluding that the bank could not track its risk of loss across its global operations. Banks have until Saturday to resubmit their capital plans to the Fed, in order to pass muster in CCAR. Thirteen banks have failed CCAR since the Fed began disclosing results with the 2012 test, according to research firm Trepp. That is about three each year. Last year, two failed on qualitative reasons. Four more were required to make specific remedies as part of conditional approvals of their plans.
About two-thirds of the banks will likely be allowed to increase their dividends, analysts at Trepp predicted in an analysis carried out before the stress test results were released. But the percentage approved for dividends has been ticking down from 72 percent in 2013 to 67 percent in 2014, and 61 percent in 2015. "Banks generally are doing pretty well on earnings, so there is capacity to increase their dividends," said Matt Anderson, managing director at Trepp.