In first round of Fed's stress tests, all 33 firms pass bar;
second round is next week
By Ryan Tracy and Donna Borak
WASHINGTON -- The largest U.S. banks have significantly
bolstered their defenses against an economic downturn, and could
continue lending even during a deep recession, the Federal Reserve
said.
That signals that many of those institutions will win
regulators' approval next week to boost dividends to investors.
In the first part of the Fed's annual "stress tests" released
Thursday, some of the country's biggest banks, such as J.P. Morgan
Chase & Co. and Citigroup Inc., fared particularly well, with
their capital ratios -- a key measure of financial strength --
increasing briskly from levels seen during last year's drill and
comfortably exceeding the level that the regulator views as a
minimum.
A senior Fed official, in a conference call with reporters,
noted the broad improvement banks had made in recent years, saying
they entered this year's exam with more capital and higher-quality
loans. They also benefited as the heavy legal costs from their role
in the financial crisis recede.
Next week, the Fed will release the second part of the tests,
which include regulators' decisions on whether to allow or block
banks' plans to return capital to shareholders through dividends or
share buybacks.
Thursday's results don't necessarily predict the Fed's verdict
next week, since in the second round the Fed judges banks not just
by their balance sheets, but by how officials assess banks'
risk-management practices.
Overall, the Fed calculated that 33 of the largest U.S. banks
would have loan losses of $385 billion under a hypothetical
scenario that envisions the U.S. unemployment rate more than
doubling to 10%, the stock market losing half its value and
financial markets becoming so topsy-turvy that short-term U.S.
Treasury rates turn negative as investors pay the U.S. government
to hold their money. Even with those big losses, they would still
have enough capital to satisfy regulators, the Fed said.
This year's exams were "arguably the most stressful stress tests
yet," said Moody's Analytics Chief Economist Mark Zandi in a
statement.
Big bank shares added to their gains of the day in after-hours
trading after the results were released, with shares of the biggest
six U.S. banks -- J.P. Morgan, Bank of America Corp., Citigroup,
Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley
-- rising between 0.3% and 2.2%.
The stress tests were created during the financial crisis and
helped in 2009 to convince panicky investors that big banks weren't
on the brink of collapse. Congress in the 2010 Dodd-Frank financial
overhaul law made annual stress tests mandatory, and the Fed has
adopted its own rules tying shareholder dividends to the tests.
The goal is to force banks to manage their finances in a way
that they would be able to keep lending during the worst economic
conditions and to diminish the risk of big bank failures.
The stress tests are just one of several new drills that
regulators have been running with banks to prevent a new
crisis.
They also have to file annual "living wills" which show how --
if all of those other defenses collapse and the banks find
themselves on the brink of bankruptcy -- they could be unwound
without an infusion of taxpayer funds or without traumatizing the
broader financial system.
Despite Thursday's results, Fed officials say they are going to
force the very largest banks to maintain even more capital, in part
because stress tests won't necessarily anticipate the source of the
next crisis.
Critics say the Fed programs are overkill, going to extremes to
prevent a crisis while hampering the economy's ability to recover
from the last one.
"I think the Fed is trying to make these entities fail-proof; I
think it's kind of spilling over the entire financial community,"
Rep. Randy Neugebauer (R., Texas) told Fed Chairwoman Janet Yellen
during a congressional hearing Wednesday. "We've got economists
trying to run banks," he added, blaming that for "anemic
growth."
The stress tests "will make you very safe," Bank of America
Corp. CEO Brian Moynihan told a Wall Street Journal conference last
week. "The question is whether it restricts lending."
Fed defenders say the tests have made banks stronger, and
stronger banks make more loans than weaker ones.
This is the second year in a row in which all the banks taking
the tests maintained capital levels above what the Fed views as a
minimum allowance. The Fed said the banks collectively maintained
at least 8.4% high-quality capital as a share of assets, staying
well above the Fed's 4.5% minimum even after being pounded by a
severe economic downturn. That was also better than the 7.6% in
high-quality capital they maintained in last year's test. The banks
collectively started this round of tests with 12.3% capital at the
end of 2015.
The Fed says banks have more than doubled their capital since
2009, boosting common equity by more than $700 billion.
The Fed changes the details of its recession scenarios from year
to year, so the specifics can hit one type of bank harder than
another. Relative to last year, this year's negative-rate scenario
took a tougher toll on traditional banking businesses that rely on
deposits as a source of funding, the senior Fed official said. That
was a contrast from last year, when large trading banks were harder
hit than in the past because the Fed in that scenario assumed
significant corporate defaults. The low-rates scenario also helped
to boost trading revenue for the biggest banks by limiting
stock-price declines and market volatility, the Fed official
said.
This led all six of the biggest U.S. banks to show higher
predicted net revenue before credit losses in the test. J.P.
Morgan's predicted revenue more than doubled compared with last
year's exam, and that of Goldman Sachs quintupled. That, along with
a higher starting point for their capital bases, helped all six
post minimum capital levels in the test that were higher than those
registered in last year's exams.
In addition to running the stress tests on their current balance
sheets, the banks have also submitted to the Fed their desired
plans to return capital to investors, making the case that they
could pass the test even after making those payouts.
If the firms determine, based on Thursday's results, that their
capital plans would push them below the Fed's minimum required
threshold, they have until Saturday to take a one-time shot at a
"mulligan" -- cutting their request for dividends or buybacks to
stay above the Fed's minimum requirement.
--Christina Rexrode and Emily Glazer contributed to this
article.
Write to Ryan Tracy at ryan.tracy@wsj.com and Donna Borak at
donna.borak@wsj.com
(END) Dow Jones Newswires
June 24, 2016 02:47 ET (06:47 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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