The 35 largest U.S. banks are poised to put more money toward dividends, share buybacks and business investments, after clearing the first stage of an annual regulatory stress test on Thursday, showing they have enough capital to withstand an extreme recession.
Although the lenders would suffer $578 billion in total losses in the Federal Reserve’s most severe scenario to date, their level of high-quality capital would be greater than the threshold that regulators demand – and above levels seen immediately leading up to the 2007-2009 crisis, the Fed said.
Thursday’s results are the first of a two-part exam, showing whether banks would meet minimum requirements under the Fed’s methodology, using materials they submitted. Some might still stumble in next week’s second, tougher test, which includes operational factors like risk management.
“This is the science and next week is the art,” said Mike Alix, financial services risk leader at PwC. “This is the mathematical calculation that shows there are robust levels of capital for most firms. Next week will be the judgment.”
The Fed introduced the stress tests during the financial crisis to ensure the strength of the banking industry, whose ability to lend is considered crucial to the health of the economy.
Since the first test in 2009, banks have seen losses abate, loan portfolios improve and profits grow. The banks that now undergo the exam have also strengthened their balance sheets by adding more than $800 billion in top-notch capital, the Fed said.
U.S. subsidiaries of six foreign lenders, including Deutsche Bank, Credit Suisse Group AG and UBS Group AG, also go through the test and had their results publicly released for the first time.
Deutsche Bank, whose U.S. operations have been under intense regulatory scrutiny, also easily met all the minimum capital requirements, as did Credit Suisse and UBS, the results showed.
Other banks tested include household names like JPMorgan Chase & Co, Citigroup Inc, Bank of America Corp and Wells Fargo & Co, as well as major regional lenders like Capital One Financial Corp, PNC Financial Services Group Inc and U.S. Bancorp and Wall Street banks Goldman Sachs Group Inc and Morgan Stanley.
Banks investors view the test as a hurdle for capital returns through stock buybacks and dividends. It could also boost the case for regulatory relief promised by the Trump administration.
The Fed increases the difficulty of the test as the broader economic environment improves. This year the test features a severe global recession with the U.S. unemployment rate rising by almost 6 percentage points to 10 percent, accompanied by a steepening Treasury yield curve.
Some banks’ results were hurt this time by the new federal tax law, which changed the impact of past losses on hypothetical tax bills under the scenarios, senior Fed officials said.
The second portion of the test will be released on Wednesday. Those results will determine whether the Fed approves or denies capital plans. Banks now have an opportunity to resubmit those plans if they find their own projections were much sunnier than the Fed’s.