Fed says tests show 17 of 18 biggest US banks in stronger position to face sharp recession

WASHINGTON – All but one of the nation’s 18 largest banks are more prepared to withstand a severe U.S. recession and a global downturn than at any time since the 2008 financial crisis, the Federal Reserve says.

Results of the Fed’s annual “stress tests” showed Thursday that as a group, the 18 banks hold fewer bad loans compared with last year, thanks to a stronger economy. The Fed will announce next week whether it will approve the banks’ plans to increase dividends or repurchase shares.

The Fed’s data show that one of the banks, Ally Financial Inc., would have a much lower capital buffer against losses than the others under the most severe scenario. Ally’s projected capital level is below the minimum that the Fed considers a bank would need to survive a severe recession.

But Fed officials wouldn’t say whether that means it would reject Ally’s request for issuing dividends or buying back shares, if Ally were to make one.

Last year, government-owned Ally — the former financial arm of General Motors — was the worst-performing bank in the Fed’s stress tests. It was one of four banks that failed the tests and were not allowed to raise their dividends or repurchase shares. The others were Citigroup Inc., SunTrust Banks Inc. and MetLife Inc., which has since sold its banking operations and is no longer tested.

Citigroup objected to any characterization that it had failed the 2012 test. It said it had enough capital to withstand the Fed’s crisis scenario, just not enough to do that and raise its dividend at the same time.

In a statement, Ally countered that it is well-capitalized and called the Fed’s analysis for calculating the bank’s potential losses “fundamentally flawed.”

“While Ally appreciates the Fed’s role in ensuring that financial institutions have adequate capital during stressed situations, using flawed assumptions could have lasting adverse impacts on the economy, including ultimately causing banks to reduce certain key lending categories,” the bank said.

The 18 banks were tested on how they would withstand severe downturns not only in the United States but also in Europe and in Asian countries including China and Japan.

Under the stress tests’ most severe scenario, the United States would undergo a recession in which unemployment would reach nearly 12 per cent, stocks would lose half their value and home prices would plunge 20 per cent.

The Fed said that under that crisis scenario, the 18 banks would suffer combined losses of $462 billion through the fourth quarter of 2014.

The Fed has conducted stress tests of the largest banks every year since 2009 in the aftermath of the financial crisis.

Next Thursday, the Fed will announce whether it has approved each bank’s request, if one has been made, to raise dividends for its shareholders. Its decisions will be based on how each bank would fare in a severe recession if it increased its dividends.

“The stress tests are a tool to gauge the resiliency of the financial sector,” Daniel Tarullo, a Fed governor, said in a statement.

Tarullo said significant increases in the amount and quality of banks’ capital cushions against risk “help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.”

The 18 banks, along with hundreds of other U.S. banks, received federal bailouts during the financial crisis that struck in 2008 and triggered the worst economic downturn since the Great Depression of the 1930s. The banking industry has been recovering steadily since then, with overall profits rising and banks starting to lend more freely.

Many longtime bank shareholders are unhappy with their investments, because most banks’ stock prices still have yet to return to pre-crisis levels. But raising dividends costs a bank cash. The government doesn’t want banks to deplete their capital reserves so much that they’d become vulnerable to another recession.

Citigroup and Bank of America Corp. are each still paying shareholders only a token dividend of 1 penny, because the government hasn’t allowed them to raise it.

Citigroup said Thursday that it has asked the Fed for permission to buy back $1.2 billion of its stock. The bank did not ask to raise its dividend.

Bank of America, Morgan Stanley, Wells Fargo & Co., Goldman Sachs Group Inc., BB&T Corp., JP Morgan Chase & Co., and U.S. Bancorp released the results of their own stress tests, using the scenario that the Fed had envisioned. They all predicted that their capital levels would be higher than the Fed’s estimate.

Citigroup, by contrast, predicted that its capital level would be slightly lower than the Fed’s estimate, though still meeting regulatory requirements.

Wells Fargo noted that the Fed doesn’t fully disclose its models and methodologies for the stress tests. “As a result, we are unable to explain the basis for any variances between our projections and the projections of the Federal Reserve,” the bank said.

Some experts say they aren’t sure that even a thumb’s-up from the stress tests carries much significance. The industry is no longer in dire shape, but it’s still under pressure. Uncertain legal fees and new regulations are restraining profits and revenue, and demand for loans has been generally lacklustre.

Chris Whalen, a New York-based analyst, argued that the Fed appears too eager for banks to return capital to shareholders. He said the industry still faces problems.

“Weak profitability and slow revenue growth should be the key areas of concern in the (stress test) analysis, but there will be no discussion of these factors,” Whalen wrote in a post shortly before the results were released.

The other banks tested were American Express Co., Bank of New York Mellon Corp., Capital One Financial Corp., Fifth Third Bancorp, KeyCorp, PNC Financial Services Group Inc., Regions Financial Corp. and State Street Corp.


Rexrode reported from New York.