All 33 U.S. banks that underwent regulatory stress tests this year were able to withstand a severe economic downturn while staying above minimum-required capital levels, the U.S. 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 — but all the banks would be able to keep lending.
The results released 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 2007-09 financial crisis. It relies on standardized assumptions about capital levels and distributions for the tested banks, allowing for a consistent view across the industry.
As part of DFAST, the Fed subjects the banks' books to what amounts to a hypothetical economic horror scenario, not unlike the financial crisis of 2008.
The scenario is a severe global recession in which U.S. economic output begins to decline in 2016 and troughs in early 2017 at 6.25 percent below its peak. Unemployment would rise to 10 percent, stock prices would fall by half and home prices would drop 25 percent by 2018.
The 33 banks the Fed looked at include the two largest banks that operate in Minnesota, Wells Fargo and U.S. Bank. Both passed the test.
U.S. Bank's Tier 1 common equity as a portion of risk-weighted assets would drop to 7.5 percent, as the bank would suffer $18.9 billion in loan losses over two years. Wells Fargo's equity ratio would drop to 7.2 percent as the bank would suffer $51.8 billion in loan losses.
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.
Staff writer Adam Belz contributed to this report.
