Late on March 20, the Fed released the results from the supervisory stress tests conducted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As expected, nearly all of the nation’s largest banks subject to the supervisory stress test passed. Out of the 30 banks subject to the stress test, 29 of the banks passed as the minimum of their Tier 1 common ratio stayed above the 5% level under the stress-case conditions. The only bank to not meet this hurdle was Zions Bancorporation (ZION).
The results are no surprise to us, as they are generally in line with Morningstar's own Stress Test analysis. Under the Federal Reserve’s stress test, Zions would have a Tier 1 common ratio of less than 5%. For example, besides Zions, the two worst banks in the Fed's stress test were Bank of America (BAC) and M&T Bank Corporation (MTB), which ended up with stressed Tier 1 common ratios of 6.0% and 5.9%, respectively. Our credit ratings on both of these banks are comparatively low, due in part to M&T’s relatively low level of current tangible capital compared to peers, and Bank of America’s still middling profitability and lingering litigation expenses. That said, while these banks did perform below average, they are far from being "in trouble". The Fed noted in its press release that all the large banks are "collectively better positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago," which has been Morningstar's opinion of the large banks for some time.
We also are interested to see that estimated losses relating to trading activities and large counterparty failures were manageable across the universe of large banks – totalling only $57.4 billion – in the Fed’s adverse scenario, as public information on individual counterparty exposures is scarce. For Bank of America, Citigroup (C), and JPMorgan Chase (JPM), these estimated losses pale in comparison to projected pre-provision net revenue. We’re therefore marginally more comfortable with the banks’ nominally massive exposures as a result of the disclosed loss estimates.
Next on the calendar for the Fed is the March 26 release of the results from the Comprehensive Capital Analysis and Review. The CCAR takes into account each company's capital plans, such as dividend payments, stock repurchases, or planned acquisitions. The Fed basically evaluates whether each bank would still pass the stress test even after planned capital releases. Last year, JPMorgan and Goldman Sachs Group (GS) were required to submit revised capital return plans by the end of third-quarter 2013. We do not expect any of the banks to make the mistake of requesting capital returns that would be deemed excessive by the Federal Reserve given their past experience with this process.
