FED STRESS TESTS FIND U.S. BANKS COULD TAKE BIG HIT / THE FINANCIAL TIMES

Last updated: March 20, 2014 11:16 pm

Fed stress tests find US banks could take big hit

By Tom Braithwaite and Camilla Hall in New York and Gina Chon in Washington

©AFP

The US Federal Reserve Building

Federal Reserve stress tests found Bank of America, Morgan Stanley and Goldman Sachs would suffer huge losses in a financial crisis, curbing their ability to return capital to shareholders.

All the major US banks passed the tests, which modelled a hypothetical recession and market meltdown to gauge the resilience of the financial system. Of 30 banks tested, only Zions, a Utah-based lender, failed to maintain a minimum capital ratio of 5 per cent equity to risk-weighted assets.

But BofA, Morgan Stanley, JPMorgan and Goldman all came out with less than a 7 per cent capital ratio – much weaker than anticipated.

In the crisis scenario, BofA would make a $49.1bn loss, the worst performance of any of the banks and its capital ratio would plummet to 6 per cent before any share buybacks or higher dividends.

The tests were used as the basis for the Fed’s assessment of banks’ capital return plans, which will be released on Wednesday.

Any bank whose dividend and buyback plans would cause it to burn through the 5 per cent capital threshold could suffer an embarrassing veto by the Fed and have to resubmit a lower request.

Those requests are private until next week. However, there are clues on whether those weaker performers risk a Fed veto, which in previous years has dealt blows to the credibility of BofA and Citigroup.

Analysts warned that on more than one measure of capital, BofA was close to the limit.

“It’s narrower than you’d like,” said Glenn Schorr, analyst at ISI Group in New York, adding that BofA should still have excess capital to allow for its share buyback and dividend plans.

JPMorgan’s stressed ratio of 6.3 per cent equates to about $17bn above the 5 per cent minimum. The bank has signalled that it intends to ask permission for a capital return of less than $10bn and therefore should pass – though the Fed can still fail an institution if examiners find other weaknesses in its capital planning.

The overall picture in the fourth round of stress tests since 2009 showed the US financial system with much more loss absorbent capital than it had five years ago, making it better able to withstand a severe shock.

The Fed found that the largest US banks would lose a total of $501bn under the crisis scenario – which included a severe recession with an unemployment rate of more than 11 per cent.

Given the settlements and fines that banks have paid to resolve allegations of wrongdoing, the Fed asked banks to pay particular attention to litigation exposure for this year’s test, central bank officials said. Operational risk losses were about 45 per cent higher this year, largely because of litigation expenses.

One of the differences in this year’s test was that the Fed used its own calculations for balance sheets and risk-weighted assets. That meant, while banks assumed a smaller balance sheet in a crisis situation, the Fed projected a small increase in their balance sheets. Fed officials said the bar would continue to rise over the next several years.

The aggregate tier one common capital ratio, which compares high-quality capital to assets measured on a risk basis, would drop to a minimum of 7.6 per cent in a crisis situation, compared with the 11.5 per cent recorded by the banks in the third quarter of 2013.

Overall, the total amount of tier one common capital held by the 30 banks subject to the tests fell more than $396bn, or about 41 per cent.

State Street, Discover Financial Services and Bank of New York Mellon emerged as the strongest banks in a crisis when it came to tier one capital ratios, with all of them having a minimum of at least 13 per cent.

Wells Fargo improved its capital ratio to 8.2 per cent, the strongest of the six biggest US banks.

“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,” said Moshe Orenbuch at Credit Suisse in New York.

Bank holding company	Stressed Ratios “Tier one common” capital as a percentage of risk- weighted assets
Ally Financial	6.3
American Express	12.6
Bank of America	6
Bank of New York Mellon	13.1
BB&T Corporation	8.2
BBVA Compass Bancshares	8.5
BMO Financial	7.6
Capital One Financial	7.6
Citigroup	7
Comerica	8.4
Discover Financial Services	13.1
Fifth Third Bancorp	8.3
Goldman Sachs	6.8
HSBC North America	6.8
Huntington Bancshares	7.4
JPMorgan Chase	6.3
KeyCorp	9.2
M&T Bank Corporation	5.9
Morgan Stanley	6.1
Northern Trust Corporation	11.4
PNC Financial	9
RBS Citizens	10.7
Regions Financial	8.8
Santander Holdings USA	7.3
State Street	13.3
SunTrust	8.7
U.S. Bancorp	8.2
UnionBanCal	8.1
Wells Fargo	8.2
Zions Bancorporation	3.5

Copyright The Financial Times Limited 2014.