Goldman Sachs Group Inc. and Citigroup Inc. staked out sharply divergent views from the Federal Reserve over how well they would perform in a market shock, as the central bank gauges the strength of U.S. lenders. Such discrepancies can lead the Fed to reject plans to pay out capital to shareholders.
Stress-test projections released by the Fed and U.S. firms showed Goldman Sachs predicted its Tier 1 common ratio, a measure of the firm’s ability to absorb losses, would be 3.9 percentage points higher than what the Fed estimated in a worst-case scenario. New York-based Citigroup calculated a ratio 3 percentage points stronger than the central bank’s figure.
The Fed’s test measures how well banks can weather economic turmoil, before the regulator signals in a second stage whether firms can proceed with proposed dividends and stock buybacks. While figures released by the central bank showed that 29 of the 30 largest U.S. lenders could withstand a deep recession, Fed officials have said they’ll also consider the quality of banks’ processes when approving or rejecting proposed payouts. That announcement is set for March 26.
“If the bank really appears to be an outlier relative to the Fed test it has to speak to their own capital-planning process,” Todd Hagerman, an analyst at Sterne Agee & Leach Inc. in New York, said in a phone interview. “If one of those companies had a fairly wide disparity between its own model and the Fed’s model, that’s going to raise red flags.”
Last year, the large banks whose figures split most from the Fed’s -- Goldman Sachs and JPMorgan Chase & Co. -- were forced to submit new capital plans to address weaknesses in their processes. The New York-based firms were allowed to continue payouts in the meantime. While the regulator posted results for every bank in this year’s first round, not all of them released their own calculations yesterday for comparison.
JPMorgan, the nation’s largest bank, estimated this time that its Tier 1 common ratio would fall to a level that differed by only 0.2 percentage point from the Fed’s estimate. Bank of America Corp.’s figure was more optimistic than the Fed’s by 2.6 percentage points. Morgan Stanley’s gap was 2 percentage points. Wells Fargo & Co.’s was 1.5 percentage points.
“We think there is some possibility that BAC may have to resubmit its capital-return request,” Moshe Orenbuch, an analyst at Credit Suisse Group AG, wrote in a research note, referring to Bank of America’s stock symbol. He cited the firm’s “differential” from the Fed as a reason.
Spokesmen for all six lenders declined to comment. Analysts estimate that the 23 publicly traded banks in this year’s tests can afford to pay out more than $75 billion in excess capital to investors if the Fed signs off on their plans.
The Fed tests are designed to prevent a repeat of the 2008 financial crisis, when the U.S. created a $700 billion taxpayer-funded bailout program for banks.
Firms in this year’s tests must describe what would happen to capital ratios, revenue and loss rates on various assets in dire scenarios described by the Fed. Eight of the biggest banks also must demonstrate they can handle the sudden demise of their trading partner with the potential for greatest losses.
Yesterday’s results show big U.S. banks “are collectively better positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago,” the Fed said in a statement. “This result reflects continued broad improvement in their capital positions since the financial crisis.”
The central bank tested firms under two scenarios. Its “adverse” case gauges what would happen to the value of their existing holdings of riskier commercial loans should yields rise as high as 9.2 percent in this year’s third quarter. In the Fed’s “severely adverse” environment, the unemployment rate peaks at 11.25 percent, stocks fall almost 50 percent and U.S. housing prices slide 25 percent, while the euro area sinks into recession.
Each party uses its own model to produce estimates of losses and capital ratios, which can vary.
“Because we employ models and methodologies developed by us, our results will differ, potentially significantly, from projections that the Federal Reserve will make,” San Francisco- based Wells Fargo, the largest U.S. mortgage lender, wrote in a presentation of its figures.
The Fed can object on quantitative grounds, such as insufficient capital, or on qualitative grounds if it finds that a company’s planning processes or controls are flawed.
“Qualitative relates to quality — if the Fed sees anything funky in the capital plans they reserve the right to send them back to the drawing board,” Nancy Bush, a bank analyst who founded NAB Research LLC in New Jersey, said in a phone interview. “That’s healthy.”
The Fed’s assumptions are so conservative that the banks’ findings can be more realistic in some cases, said R. Scott Siefers, a managing director at Sandler O’Neill & Partners LP in New York. While a “huge gap” could affect next week’s results, many things can determine whether banks win approval, he said in an interview.
Zions Bancorporation was the only lender projected by the Fed to fall below one of the main capital thresholds. The Salt Lake City-based firm’s Tier 1 common ratio would drop to as low as 3.5 percent in a severely adverse scenario, short of the 5 percent minimum used when approving capital plans in the test’s second stage, the Fed said.
Zions, which is participating in the stress tests for the first time, said earlier this year that it will refile its capital plan because a sale of some securities cut risk. Yesterday, the firm said the next submission also will include additional actions to ensure it meets the Fed’s requirements.
Among the six largest U.S. lenders, Bank of America and Morgan Stanley came closest to the regulatory minimum across the five ratios being tested.
The Fed found that Charlotte, North Carolina-based Bank of America’s Tier 1 leverage ratio would fall to as low as 4.6 percent under the “severely adverse” scenario. The same ratio at Morgan Stanley would fall to 4.7 percent. The regulatory minimum stands at 4 percent.
Such close margins don’t necessarily mean a firm’s capital plan is in jeopardy. Bank of America’s more-than $2.1 trillion in average total assets at the end of last year indicate it could return about $13 billion to investors without falling below the leverage threshold. The lender, which ranks as the nation’s second-largest bank, may have requested an average $7.2 billion over the next 12 months, according to four analysts surveyed by Bloomberg.
Morgan Stanley’s more-than $830 billion of total assets show it can return almost $6 billion before falling below the minimum. The New York-based firm, which owns the world’s biggest brokerage, may have asked to return $2.1 billion, the analysts’ estimates show.
While the Fed didn’t list asset totals for the banks, it said assets for the 30 firms combined climb during the next two years in the severely adverse scenario.
Next week, the banks also must show what capital levels would look like after taking into account their plans for acquisitions, higher dividends and stock buybacks.
“The financial system is safe and strong and the capital base is growing,” said Dan Ryan, head of PricewaterhouseCoopers LLP’s financial-regulation practice. “The average person who relies on the banking system should be happy. Next week will tell us whether banks and bank shareholders will be happy.”
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