The Federal Reserve said 29 of the 30 largest banks subjected to a stress test have sufficient capital to withstand a deep recession while continuing to pay dividends.
Zions Bancorporation is the only lender that came in below one of the Fed’s main capital thresholds in results released Thursday by the central bank that simulated a deep recession. All 30 banks, including Salt Lake City-based Zions, exceeded the minimum in a separate scenario of rising interest rates, a sign of improved capital levels in the banking system since the 2008 financial crisis.
The largest 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 while releasing data from the test required under the Dodd-Frank Act. “This result reflects continued broad improvement in their capital positions since the financial crisis.”
The Fed runs an annual two-part stress test to ensure banks have enough capital and cash to withstand shocks that may threaten their survival. The goal is to head off a recurrence of taxpayer-funded bailouts as in 2008, when government rescues averted the collapse of some of the world’s largest lenders. Firms that fail a second round of tests released next week may have to forgo stock buybacks and higher dividends.
Total projected loan losses for all 30 banks differed widely between the two scenarios. Under the adverse scenario of rising rates, banks lose $267 billion on all loans, including credit cards, commercial real estate, and mortgages. Under the severely adverse conditions, loan losses total almost $100 billion more, or $366 billion.
Fed supervisors this year scrutinized risks from litigation, counterparty failure, and high-yield loans as they guide banks toward higher capital buffers against financial and economic shocks.
In the Fed’s severely adverse scenario, Zions Bancorporation fell below a 5 percent ratio for Tier-1 common equity to total assets weighted for risk, according to data released by the central bank. Banks under this test face a deep recession, with U.S. gross domestic product collapsing at a 6.1 percent annual rate in the first quarter of 2014 and real disposable income falling at a 2.4 percent pace.
James Abbott, a spokesman for Zions, did not immediately respond to an email and phone call seeking comment.
The ratio of Tier-1 common equity to assets weighted for risk at all bank holding companies has averaged about 13 percent over the past two years, four percentage points higher than the average prior to 2009, the Fed said last month. Regulators use the ratio, which compares a firm’s common equity capital to its risk-weighted assets, to measure a bank’s cushion against losses.
“Banks are still hoarding a lot of capital; in other words, they’re generating quite a bit internally and they’re not paying it out,” R. Scott Siefers, a managing director at Sandler O’Neill + Partners LP in New York, said before the results were released. “Capital levels by and large are very, very strong.”
Banks can’t pass or fail the test released today, which doesn’t take into account management actions to preserve capital. In the tests released March 26, regulators will try to ensure those actions, such as dividend cuts, keep banks above a minimum Tier-1 common ratio of 5 percent over nine quarters in harsh economic scenarios.
Fed officials have also cautioned that even banks that exceeded all the thresholds in today’s test may still find their requests for higher payouts rejected next week if regulators find the quality of the planning is flawed. The scrutiny can extend to management, systems and even boards of directors.
The Fed said that in a severely adverse scenario, the minimum Tier-1 common ratio of Zions, based in Salt Lake City, is 3.5 percent. That’s below the 5 percent threshold, one of the regulatory measures used in next week’s test.
Zions has already notified the Fed it will resubmit its plan after determining that losses triggered by the Volcker Rule will be less than anticipated.
The rule, named after former Fed Chairman Paul Volcker and included in the 2010 Dodd-Frank Act, bans some riskier holdings. Zions said in December it would have to sell assets of this type at prices so low that annual profit could be wiped out.
Shares of Zions, led by Chief Executive Officer Harris Simmons, rose 40 percent last year, outpacing the 35 percent gain for the KBW Bank Index. The stock was the fifth best performer in the 24-company KBW Bank Index last year.
The unemployment rate in the severely adverse scenario rises to 9.9 percent in the second quarter of 2014. House prices fall 25 percent, and stock prices fall nearly 50 percent. Under the adverse scenario, the U.S. economy slumps into a recession for slightly more than a year. Stock prices drop 36 percent by the middle of 2014, house prices decline about 10 percent, and commercial real estate prices fall about 20 percent.
The most notable feature in the adverse scenario is a jump in the 10-year Treasury yield to 5.8 percent in the fourth quarter of this year. The yield currently stands at 2.77 percent. Yields on five-year Treasuries jump to 4.6 percent in the same time period, compared with 1.70 percent now, and rates on BBB corporate bonds jump to 9.1 percent.
The stress-test regime has evolved into two exams. Thursday’s results are from the Dodd-Frank Act Stress Test and will be followed March 26 by an exam with input from bank management on capital, known as the Comprehensive Capital Analysis and Review.
The test aims to give regulators a cross-section view of the banking system, with dividends held constant into future months.
Next week’s results will be more significant because banks that can show capital surpluses even through dire economic scenarios are typically given a pass by regulators on dividend increases and stock buybacks.
Jason Goldberg, a bank-stock analyst in New York for Barclays Plc, told clients in a note this week that dividends for large banks will continue to rise this year.
“We expect this to mark the fourth straight year the median bank’s dividend payout ratio increases,” Goldberg said in the note.
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