The Federal Reserve, exercising sweeping new authority to ensure financial stability, will show how the capital of the 19 largest U.S. banks might fare through a deep recession and a second housing crisis and use the results to dictate which of them can increase their dividends.
The U.S. central bank has conducted increasingly detailed tests of bank capital planning with the goal of assuring banks can survive an economic storm without the taxpayer-funded bailouts that sparked a political backlash following the 2008 financial crisis.
The Fed will release the results of the so-called stress tests at 4:30 p.m. on March 15, it said in a statement yesterday in Washington. The tests will show results for revenues, capital ratios and profits or losses at each firm over a nine-quarter period.
“The industry has a record amount of capital and much cleaner balance sheets than two years ago,” said Jason Goldberg, senior analyst at Barclays Capital Inc. in New York. The results “are going to show the banking industry is on solid ground.”
In past stress tests, the 19 bank holding companies have boosted their tier one common capital levels to $759 billion in the fourth quarter of 2011 from $420 billion in the first quarter of 2009, the Fed said yesterday.
Bank shares have soared this year as investors bet a strengthening economy will help firms boost earnings, with the KBW Bank Index (BKX) of 24 U.S. lenders advancing 15 percent. 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.
More Common Equity
The Fed yesterday said the increase in capital partly reflects the central bank’s “move to ensure the firms reduced or eliminated dividends to maintain safety and soundness.” The banks paid out 15 percent of net income in common dividends in 2011, compared with 38 percent in 2006, the Fed said. They also raised more in common equity than they repurchased in 2011.
For the current test, the Fed provided the banks with 25 variables, including estimates on gross domestic product, Treasury bill rates and indexes of consumer prices and home prices. The recession scenario assumes an 8 percent drop in U.S. gross domestic product, an unemployment rate as high as 13 percent and a 21 percent plunge in home prices.
“Strong capital levels are critical to ensuring that banking organizations have the ability to lend and to continue to meet their financial obligations, even in times of economic difficulty,” the Fed said in its statement. It said the stress test scenario isn’t a forecast for the economy.
‘Global Market Shock’
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 Fed said. The six are Citigroup Inc. (C), Bank of America Corp. (BAC), Wells Fargo & Co., Morgan Stanley, Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co.
Fed Chairman Ben S. Bernanke began to formulate the stress tests in late 2008 when he asked supervisors to determine the extent of losses facing the nation’s largest lenders following the collapse of Lehman Brothers Holdings Inc.
Disclosure of stress-test results in May 2009 boosted confidence in the financial system by giving investors more certainty on the maximum losses banks might sustain. Stock indexes started to recover in March 2009, and the 18-month recession end in June.
Stress tests are now an annual requirement for the largest banks under the Dodd-Frank Act overhauling financial regulation. The Fed has in recent years focused more on forward capital planning with an eye toward how much banks intended to pay out to shareholders. To make up for capital shortfalls, taxpayers provided $245 billion in bailouts through the Troubled Asset Relief Program during the financial crisis.
Bankers have bristled at regulators’ grip on decisions once made by boards with lighter oversight.
JPMorgan Chase & Co. (JPM) Chairman and Chief Executive Officer Jamie Dimon was asked by an analyst in July if he would seek Fed approval to pay out additional capital.
“I think it is important to point out that the board is responsible for this company, not just the regulators,” Dimon responded, according to a transcript of the July 14 conference call. “It is still America. Capitalism is still alive.”
To conduct the latest analysis, the Fed drew on some of its 275 Ph.D. economists at the Fed Board, who hold expertise in macroeconomic forecasting, international economies and computer modeling of economic scenarios.
“The assumptions were pretty extreme,” said Gilbert Schwartz, a former Fed attorney and a partner at Schwartz & Ballen, a Washington law firm. He questioned why such a dire scenario was necessary “when we are being told this isn’t going to happen again because of all the institutional safeguards.”
Other banks participating in the tests include Ally Financial Inc., American Express Co., Bank of New York Mellon Corp., BB&T Corp., Capital One Financial Corp., Fifth Third Bancorp, Keycorp, MetLife Inc., PNC Financial Services Group, Inc., Regions Financial Corp., State Street Corp., SunTrust Banks Inc., and U.S. Bancorp.
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