Fed stress tests show most big U.S. banks can weather shock

Banks have built reserves during economic expansion

March 13 (Bloomberg) -- The Federal Reserve said 15 of the 19 largest U.S. banks could maintain adequate capital levels even in a severe recession that assumes they keep paying dividends and buying back stock.

Today’s results of the central bank’s stress tests show that nearly three years of economic expansion have helped U.S. banks raise profits, rebuild capital, and increase liquidity after the collapse of Lehman Brothers Holdings Inc. in 2008 nearly toppled the financial system.

“On the whole, the major U.S. banking organizations are well on the mend,” said Ernest Patrikis, a partner at White & Case LLP and a former lawyer for the Federal Reserve Bank of New York. “They have sufficient capital to weather a severe storm. One question is whether they will have too much capital.”

JPMorgan Chase & Co., in an announcement before the Fed’s release, said it would increase its dividend 20 percent and authorized a $15 billion share repurchase plan after the central bank test. Citigroup Inc., the lender that took the most government aid during the financial crisis, said it will resubmit its capital plan to regulators after failing to meet some minimum standards in the stress tests.

Stocks rose, sending the Dow Jones Industrial Average to the highest level since 2007, after the JPMorgan Chase dividend announcement and as the Fed raised its assessment of the economy.

Treasury Yields

The Standard & Poor’s 500 Index added 1.8 percent to 1,395.95 at 4 p.m. New York time, and the Dow climbed 217.97 points to 13,177.68. Yields on 10-year Treasuries advanced a fifth day, reaching 2.13 percent.

The KBW Bank Index, which tracks shares of 23 of the largest U.S. banks, including BB&T Corp. and Wells Fargo & Co., rose 4.6 percent. The index is up 21 percent this year on expectations of stronger economic growth and improving profits. Concern that the nation’s banks may be damaged by Europe’s debt crisis helped drive down the index 25 percent in 2011, its worst annual performance since 2008.

SunTrust Banks Inc., Ally Financial Inc. and MetLife Inc. also fell short by at least one measure under the central bank’s most dire economic scenario. Ally also intends to resubmit its plan, the company said in a statement.

Earlier today, Fed policy makers raised their assessment of the economy as the labor market gathers strength and refrained from new actions to reduce borrowing costs. They repeated that interest rates are likely to stay low at least through late 2014.

FOMC Statement

“The unemployment rate has declined notably in recent months but remains elevated,” the Federal Open Market Committee said in a statement. It also said “strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook.”

The Fed’s stress tests showed that an unemployment rate of 13 percent, a 50 percent drop in stock prices and a 21 percent decline in house prices would produce aggregate losses of $534 billion over nine quarters.

Even with that blow, the 19 banks would see their Tier 1 common capital ratio -- a measure of bank strength against loss -- fall to 6.3 percent in the fourth quarter of 2013 in the hypothetical scenario, above the 5 percent minimum the Fed required. The ratio was 10.1 percent in the third quarter of last year.

Capital Strategy

The Fed started the test and review of banks’ forward- looking capital strategy in November, saying they should have “credible plans” to meet tougher standards required by new regulations and to continue lending even in period of financial stress.

Of the $534 billion in total projected losses, $341 billion comes from loan-portfolio losses, the Fed said. Loans and trading portfolio and counterparty losses account for 85 percent of the total, the Fed said.

Six banking-holding companies with large trading, private equity and derivatives activities were also subjected to tests of these positions from a “global market shock.” The six were Citigroup, Bank of America Corp., Wells Fargo, Morgan Stanley, Goldman Sachs Group Inc. and JPMorgan Chase.

The stress tests are now a standard feature of the Fed’s big-bank supervision and oversight of financial risk. The concept was born in late 2008 when Chairman Ben S. Bernanke was trying to discern the maximum losses facing the banking system following the collapse of Lehman Brothers.

Paying Dividends

The Fed’s special focus on the l9 largest institutions’ capital management also reflects a wary attitude toward boards that paid out more than $43 billion in dividends as housing markets started to deteriorate in 2007, according to comments last year by Patrick Parkinson, the former director of the Fed’s Division of Banking Supervision and Regulation.

Citigroup’s proposed capital actions would leave the third- biggest bank with Tier 1 common capital of 4.9 percent, below the 5 percent minimum require by the regulators, according to today’s results. Citigroup, the third-largest U.S. bank, would meet the requirement only if it doesn’t change the amount of capital it returns to shareholders, the test results showed.

A senior Fed official said in a conference call with reporters that the central bank’s models showed higher estimated losses than those submitted by the banks, while declining to specify in what categories.

The results were originally due to be announced on March 15. The official said the results were released early because of a possible inadvertent release of information. The official said JPMorgan Chase’s release was the result of miscommunication between the Fed and the bank, and didn’t cause the Fed’s accelerated release of the results.

Bloomberg News

--Editors: Christopher Wellisz, Kevin Costelloe

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