By Ryan Tracy And Victoria McGrane
WASHINGTON--The largest U.S. banks are strong enough to keep
lending during a severe recession, the Federal Reserve said
Thursday, a sign that many banks will soon get permission to return
profits to investors by raising dividends or buying back
shares.
The Fed's annual "stress test" of banks' financial health found
all 31 of the biggest U.S. banks had enough capital to continue
lending during a hypothetical economic shock where corporate debt
markets deteriorate, unemployment hits 10% and housing and stock
prices plunge. The exams are designed to ensure large banks can
withstand severe losses during times of market turmoil without a
taxpayer bailout.
It was the first time since the tests began in 2009 that all
banks maintained capital levels above what the Fed views as a
minimum allowance. The banks will need to maintain those minimum
capital levels to pass the second round of stress tests on
Wednesday, which will determine whether a firm can return money to
shareholders. Two banks, Goldman Sachs Group Inc. and Zions
Bancorp, had certain capital ratios that came close to the Fed's
minimum, which could limit shareholder payouts.
The overall results buttress regulators' view that the financial
system is safer than before the Great Recession, in large part
because of loss-absorbing capital built up for the annual stress
test exercise. The Fed said the 31 banks' aggregate Tier 1 common
capital ratio, which shows high-quality capital as a percentage of
risk-weighted assets, dropped as low as 8.2% under the stressful
scenario, well above the 5.5% level measured in early 2009 and the
5% level the Fed considers a minimum allowance.
"Higher capital levels at large banks increase the resiliency of
our financial system," Federal Reserve Governor Daniel Tarullo said
in a statement.
The results could bolster big banks' push to return more of
their income to restless shareholders after years of conservative
payouts. The Fed will announce on Wednesday whether banks "pass" or
"fail" the second round of stress tests and can return their
requested amounts of capital to shareholders.
The Fed has loosened its hold on capital payouts somewhat but
they are still below precrisis levels. The payments of common-share
dividends at U.S.-owned banks in the stress test process rose to
$25 billion last year, according to data from Thomson Reuters, from
a low of $6.6 billion in 2010, when the banks were most severely
constrained. In 2007, those payouts totaled $44 billion. Citigroup,
Inc., which failed the tests last year and in 2012, hasn't been
permitted to boost its dividend since being bailed out during the
financial crisis.
Strong capital levels don't guarantee banks will get a
green-light to make payouts. As banks have boosted their ability to
absorb severe losses, the Fed has increasingly shifted its focus
toward banks' culture, governance, and ability to assess internal
and external risks. Those "qualitative" factors are now playing a
leading role in the Fed's decision about whether to approve or
reject banks' requests to pay out billions of dollars in dividends
and share buybacks.
Last year the Fed rejected Citigroup, and the U.S. units of HSBC
Holdings PLC, Banco Santander SA and Royal Bank of Scotland Group
PLC for problems related to their ability to measure and predict
risks. The U.S. units of Deutsche Bank AG, which is taking the test
for the first time this year, and Santander are expected to fail
next week due to "qualitative" factors, according to people
familiar with the matter.
Thursday's test results don't take into account banks' requests
to return more capital to shareholders in 2015 and beyond, instead
assuming that the banks maintain existing payout levels. Next
week's results will incorporate banks' plans to pay dividends or
purchase shares, moves that will likely lower their capital ratios
below Thursday's results. That could prove problematic for banks
whose capital ratios came close to the Fed's minimum allowance on
Thursday, since a payout could further deplete that capital buffer.
Goldman Sachs and Zions both had certain capital ratios close to
the Fed's minimum. The Fed looks at different measurements of
capital at each bank, including comparing capital levels against a
bank's total assets and against assets weighted by risk.
Banks will be told privately by the Fed on Thursday whether
their capital plans would put them below the Fed's minimum
threshold in next week's tests, kicking off a week of jockeying
among some banks. Any firm in that situation will have a one-time
shot at changing their request for dividends or buybacks. Last
year, Bank of America Corp. and Goldman told the Fed they wanted to
scale back their payout plans after seeing that their leverage
ratio, a measure of equity as a percentage of total assets, had
fallen below the Fed's minimum allowance. Both firms would have
failed the test without making an adjustment.
Write to Ryan Tracy at ryan.tracy@wsj.com and Victoria McGrane
at victoria.mcgrane@wsj.com
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