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Banks pass stress tests as Fed remains cautious

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Banking
Thursday, July 2, 2020

The Federal Reserve announced that all 34 of the banks which it put through stress tests had passed, but said the banks would be required to submit new capital plans later in the year to address stresses related to the pandemic.

In addition to its regular stress test, the Fed used downside scenarios which could result from the pandemic, and found that in two of the three scenarios, several banks would approach minimum capital levels.

“The banking system has been a source of strength during this crisis,” Fed Vice Chairman Randal Quarles said in a release announcing the results, “and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks.”

The three downside scenarios included a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession. In those, the unemployment rate peaked at between 15.6 percent and 19.5 percent, significantly more stringent than any of the Fed’s pre-coronavirus stress test scenarios, the regulator stated.

In aggregate, the Fed found that loan losses for the 34 banks ranged from $560 billion to $700 billion in the sensitivity analysis, and aggregate capital ratios declined from 12 percent in the fourth quarter of 2019 to between 9.5 percent and 7.7 percent under the hypothetical downside scenarios.

“Under the U- and W-shaped scenarios, most firms remain well capitalized, but several would approach minimum capital levels,” the Fed stated. “In light of these results, the board took several actions following its stress tests to ensure large banks remain resilient despite the economic uncertainty from the coronavirus event.”

For the third quarter, the Fed will require banks to suspend share buybacks and cap dividend payments, although it will allow dividends based on a formula around recent income. It also will require new capital plans.

“All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty,” the Fed stated. “The board will conduct additional analysis each quarter to determine if adjustments to this response are appropriate.”

The results of the full stress test designed before the coronavirus showed that all large banks remain strongly capitalized. The Fed said it would use the results of that test to set the new stress capital buffer requirement for these firms, which will take effect, as planned, in the fourth quarter.

American Bankers Association President and CEO Rob Nichols touted the news.

“The Federal Reserve’s latest stress test results affirm that the nation’s largest banks continue to be a source of strength for the economy and remain well-prepared to handle a range of potential economic shocks,” he said in a statement. “Their strong balance sheets and capital levels have allowed these institutions to provide critical support to the U.S. economy during the very real economic shock caused by the coronavirus. As the results make clear, even under the most adverse hypothetical scenarios banks will continue to help the nation overcome the economic challenges posed by the pandemic.”

Moody’s Analytics, meanwhile, found that the Fed’s decisions based on the stress test results were inconclusive, but left room for credit-positive actions later in the year.

“All 33 of the banking groups in the 2020 stress test exceeded the required minimum capital and leverage ratios under the Fed’s severely adverse stress scenario, which is credit positive,” Moody’s wrote. “However, several of the underlying assumptions were relaxed in 2020, which makes this year’s results less comparable with DFAST results from previous years, and the Fed did not publish results for the Comprehensive Capital Analysis and Review (CCAR).

“Furthermore, because the stress scenarios were formulated before the economic effects of the coronavirus began to crystallize in March, the Fed also applied a sensitivity analysis under three distinct economic scenarios – a V-shaped recovery, a U-shaped recovery and a W-shaped double dip recession. The results of this analysis were only disclosed in aggregate, but revealed that the U and W scenarios would significantly weaken many banks’ capital ratios, with banks in the worst-performing quartile approaching the minimum requirements, even assuming they had stopped paying common dividends and repurchasing shares at the start of 2020.”

Moody’s said it viewed the decision to suspend buybacks, cap dividends, and resubmit plans as credit positive.

“The revised capital plans will inform the Fed’s further assessment of the banks’ financial health and risks later in the year,” Moody’s wrote.

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