Fed "Stress Test" Results Are Out: Everyone Passes Even As VIX Hits 70

Tyler Durden's picture

Moments ago the Fed released the first phase of its annual stress test which, once again, found that all thirty-four of the US largest banks "passed", exceeding minimum projected capital and leverage ratios under severely adverse scenarios, based on their projected ability to withstand economic shocks, which  as Bloomberg notes, shows that "firms are getting the hang of the once-dreaded reviews." The result marks the third straight year all firms cleared the minimum requirements in the exams’ first phase, begging the question just how "stressful" this test truly is.

Today's results covered the "Dodd-Frank Act Stress Test" that measures banks’ capital under stress over the nine quarters. This year, the Fed projected supplementary leverage ratios at the largest banks. Morgan Stanley’s projected 3.8 percent ratio in a potential economic downturn was lowest - though it still cleared the 3 percent minimum, according to Bloomberg.

Under the worst case scenario, banks are projected to suffer $383 billion in losses on loans. Some other findings, courtesy of Bloomberg

  • Bank of America Corp. would suffer a $26.4 billion hit to its pretax profit under that scenario, the most of any lender.
  • Goldman Sachs Group Inc.’s projected loan-loss rate of 8.1 percent was surpassed only by commercial lenders or card issuers such as American Express Co., Capital One Financial Corp., and Discover Financial Services.
  • Wells Fargo & Co.’s $7.7 billion in trading and counterparty losses came close to firms with larger Wall Street operations, with Morgan Stanley at $9.5 billion. JPMorgan Chase & Co. led the group with $25.2 billion in losses.

Of the participant banks, every single one exceeded minimum thresholds, although Morgan Stanley performed worse than the rest on a key leverage measure, the second year it has underperformed its peers. During the second phase of last year's stress test the bank was forced to resubmit its plan to address a “material weakness”, before it was allowed to pay out capital to shareholders. Results from that round are due next week.

Another notable finding: in the Fed's forecasts for loan losses in a "severely" adverse scenario, Goldman’s projected loan-loss rate of 8.1% was surpassed only by commercial lenders or card issuers such as American Express, Capital One, and Discover Financial Services. Wells Fargo & Co.’s $7.7 billion in trading and counterparty losses came close to firms with larger Wall Street operations, with Morgan Stanley at $9.5 billion. JPMorgan Chase & Co. led the group with $25.2 billion in losses.

“This year’s results show that, even during a severe recession, our large banks would remain well capitalized,” Fed Governor Jerome Powell said in a statement announcing the central bank’s findings Thursday.

It remains to be seen if that will also be the case when over $2 trillion in excess reserves which pad the bank's balance sheets are eventually drained.

The "successful" outcome will boost the industry's arguments that the banking system is safe enough to allow for cutting back some regulations. Furthermore, once the second round is released, expect all banks to further boost payouts to investors.

The "test" designed to boost confidence in the banking sector after the financial crisis, assesses how banks would handle hypothetical turmoil, such as surging unemployment, a sharp drop in housing prices or an extended stock slump. Firms that handily clear the first phase typically have more room to make payouts to shareholders.

The tests have become less dramatic in recent years with fewer quantitative failures. And under regulators selected by President Donald Trump, that may continue. The Treasury Department issued a report last week proposing tests occur less frequently, that highly capitalized banks be exempt from the process and that one of the toughest hurdles be scrapped.

Here are the parameters for what the Fed defined as the "Severely Adverse", or worst-case, scenario:

The adverse scenario is characterized by weakening economic activity across all of the economies included in the scenario. This economic downturn is accompanied by a global aversion to long-term fixed-income assets that, despite lower short rates, brings about a near-term rise in long-term rates and steepening yield curves in the United States and the four countries/country blocks in the scenario.


The severely adverse scenario is characterized by a severe global recession that is accompanied by a period of heightened stress in corporate loan markets and commercial real estate markets. In this scenario, the level of U.S. real GDP begins to decline in the first quarter of 2017 and reaches a trough in the second quarter of 2018 that is about 6½ percent below the pre-recession peak. The unemployment rate increases by about 5¼ percentage points, to 10 percent, by the third quarter of 2018. Headline consumer price inflation falls to about 1¼ percent at an annual rate by the second quarter of 2017 and then rises to about 1¾ percent at an annual rate by the middle of 2018.


As a result of the severe decline in real activity, short-term Treasury rates fall and remain near zero through the end of the scenario period. The 10-year Treasury yield drops to ¾ percent in the first quarter of 2017, rising gradually thereafter to around 1½ percent by the first quarter of 2019 and to about 1¾ percent by the first quarter of 2020. Financial conditions in corporate and real estate lending markets are stressed severely. The spread between yields on investment-grade corporate bonds and yields on long-term Treasury securities widens to about 5½ percentage points by the end of 2017, an increase of 3½ percentage points relative to the fourth quarter of 2016. The spread between mortgage rates and 10-year Treasury yields widens to over 3½ percentage points over the same time period.


Asset prices drop sharply in this scenario. Equity prices fall by 50 percent through the end of 2017, accompanied by a surge in equity market volatility, which approaches the levels attained in 2008. House prices and commercial real estate prices also experience large declines, with house prices and commercial real estate prices falling by 25 percent and 35 percent, respectively, through the first quarter of 2019.


The international component of this scenario features severe recessions in the euro area, the United Kingdom, and Japan and a marked growth slowdown in developing Asia. As a result of the sharp contraction in economic activity, all foreign economies included in the scenario experience a decline in consumer prices. As in this year’s adverse scenario, the U.S. dollar appreciates against the euro, the pound sterling, and the currencies of developing Asia but depreciates modestly against the yen because of flight-to-safety capital flows.

In other words, neither inflation, nor 10Y yields drop negative even as VIX surges to 70. Mmmk then.

And here is the VIX scenario that the Fed believes all banks will survive:


Considering none other than JPMorgan last week predicted that a token increase in the VIX from 10 to 15 would lead to "catastrophic losses" for vol sellers, we wish the Fed - and banks - the best of luck surviving, as the Fed expected, when the VIX hits the level it was at when the US banking system was collapsing 9 years ago.

Some other findings courtesy of Bloomberg:

  • Firms boosted share of agency MBS, Treasuries in securities portfolios, cut holdings of less-liquid assets like securitized products
  • Loan portfolios grew, driven by strong growth in corporate, commercial real estate (CRE), credit-card loans
    • Residential mortgage growth lagged, as healthy growth in first-lien mortgages was offset by notable decline in home- equity loans
  • Credit quality of some loan portfolios -- including first-lien mortgages and commercial mortgages -- has improved, largely due to recent gains in real estate prices
  • At the same time, improvements in portfolios secured by real estate were partially offset by continued stress on some corporate loans due to persistently low oil prices, recent uptick in delinquency rates in credit-card portfolios
  • Results overall show banks have strong capital levels, retain ability to lend to households and businesses during severe recession
    • Most-severe hypothetical scenario projects $493b in losses at the 34 participating banks during the 9 quarters tested, with $383b in accrual loan portfolio losses, $86b in trading and/or counterparty losses at the 8 cos. with substantial trading, processing, custodial operations
    • Companies’ aggregate common equity tier 1 capital ratio would fall to minimum level of 9.2% from actual 12.5% in 4Q 2016
    • In "adverse" scenario (featuring moderate recession), aggregate common equity capital ratio fell to minimum 10.7% from actual 12.5% in 4Q
  • Since 2009, the firms have added >$750b in common equity capital

On June 28, at 4:30pm, the Fed will release the results of the second round of the Stress Test, the Comprehensive Capital Analysis and Review (CCAR).

Full stress test below (Federal Reserve link)

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Blue Balls's picture

Good.  More lost credibility a year from now.

Cognitive Dissonance's picture

You can't find what you ain't looking for.

Chuck Norris's picture

They also said that not even God could sink the Titanic.... oops....

Mr. Universe's picture

You have to admit they are masters of "doing God's work". I remember all the talk of how raising interest rates was going to start the dominoes falling in the largest crash in history. 3 upticks later and the plates are still on their sticks spinning merrily away. "How long can this go on?" you ask. Depends on how much money you have left.

Justin Case's picture

The last full cycle of rate increases occurred between June 2004 and June 2006 as rates steadily rose from 1.00% to 5.25%. That was hike in 24 mths. A quarter of a point over a year  is hardly an increase. They are tip toeing through this conundrum they created. Can you imagine the Volker rate hikes now?

DeadFred's picture

How did Banco Popular do? They passed the last one... oh yes, that was the ECB. I'm sure the Fed won't pull a big miss like that.

targayren hous's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.jobproplan.com

True Contrarian's picture

DB 5 yr CDS chart will look like the north face of the Eiger.

Trading at $16.74 now. My money is on sub $12 next year. Coco trigger level breach could see a real selloff. Bye bye interbank lending at that rate.

junction's picture

This stress test is comparable to the college test scores of basketball stars who graduate and then are found to be illiterate.  

Kidbuck's picture

When you can give the banksters unlimited free money and fuck the value of those bucks for everone else, of course everything smells like roses.

CrabbyR's picture

Well if they are wrong this is a document that proves their incompetance with their own words

gold rubeberg's picture

Good cuz the real stress test comes next year.

Chris88's picture

You mean 2020 with the maturity wall?  Of which these banks typically have 2.0x leverage to upper middle market borrowers?

Blue Balls's picture

Time tables and finance....Black swan....Don't think it will play out that way.

Chris88's picture

Play out in which way?  

Blue Balls's picture

Plan for Janet.  Pretty sure she pops this bubble about June to September.

Chris88's picture

How's that pop a bubble on floating rate, leveraged loans, in the cov-lite BSL market where leverage levels are very, very low (usually 2.0x, or the revolver at banks) in many upper middle market companies that cycled 10% in the crisis?

Chupacabra-322's picture

Pass that Crack Pipe.....

Countrybunkererd's picture

The Titanic was unsinkable and operating at full speed after it passed it's tests too.  <<takes pipe, ahhhh...>>  why am i shaking?  The "banks" being regulated will not be the issue this time.  The highly secretive CB's will cause this one.

Chris88's picture

For once, the Fed is right.  US banks are very well-capitalized, although I am unsure of what toggles they are using and the assumptions on how said toggles will impact TCE/TA.  Cue the "couldn't read a balance sheet and never analyzed a fin services company" comment onslaught in 3, 2, 1...

Yars Revenge's picture

Not as well capitalized as Canadian, Singapore and Swiss banks (excluding UBS and credit suisse).

Chris88's picture

RBC's TCE/TCA ~ 6.1%, most US banks are 8.50%-9.00%.  I haven't checked the other Canadian banks, but I'd take a closer look.  Not to mention Canadian banks don't have leveraged lending restrictions like their US counterparts.  Oh, BTW, Goldman is 9.7%.  

CrabbyR's picture

So in plain english canadian banks are on stilts, and US banks are on solid ground?

Chris88's picture

RBC is undercapitalized (I didn't check TD and the other big 3 there), most US banks are not, EU banks are atrocious, Chinese banks are very, very undercapitalized.

CrabbyR's picture

Here`s the rub....Even with extreme understanding , The banks are opaque unless you are at the top, novice or expert how much do you know?

Chris88's picture

There is a black box effect to nearly any public company, and yes, large banks are even more so the case.  I'm not disagreeing there, but with enough experience of analyzing these over many years as well as tons of other fin services companies, you get a pretty damn good idea about what's going on.  To your point, what amazes me is the people that couldn't understand a tiny community bank think they have all the bulge bracket ones figured out.

CrabbyR's picture

I don`t claim to have any of them figured out...the big catch for me is how valuations are rocketing while profits drop...signals a false market or a collapse

not sure which however not being in the inner circle signals a divorce from your cash...LOL

Chris88's picture

Not saying you claim that, Crabby, I was referring to thge other morons here.  

Chupacabra-322's picture

The vast majority of ZH's especially the veterans here understand fully that there are no more "Bear or Bullish" markets. There's only Fascism & Ponzi.

"If central banks purchase stocks in order to support equity prices, what is the point of having a stock market? The central bank’s ability to create money to support stock prices negates the price discovery function of the stock market."?-Dr. Paul Criag Roberts

"These questions came to mind when we learned that the central bank of Switzerland, the Swiss National Bank, purchased 3,300,000 shares of Apple stock in the first quarter of this year, adding 500,000 shares in the second quarter. Smart money would have been selling, not buying.

It turns out that the Swiss central bank, in addition to its Apple stock, holds very large equity positions, ranging from $250,000,000 to $637,000,000, in numerous US corporations — Exxon Mobil, Microsoft, Google, Johnson & Johnson, General Electric, Procter & Gamble, Verizon, AT&T, Pfizer, Chevron, Merck, Facebook, Pepsico, Coca Cola, Disney, Valeant, IBM, Gilead, Amazon."
-Dr. Paul Craig Roberts


My friends,

this is from 2015.

Chris88's picture

The vast majority here don't work in the industry and are clueless.  The readership here has certainly gone downhill.

Countrybunkererd's picture

Just yesterday the ECB admitted to buying companies directly to the tune of 15% of bond purchases.  How will that go when the balance sheet of a non central bank is stressed when the spiked punch is removed?  Enlighten me, i am not in the industry.  That is why I am at ZH, to learn.

Chris88's picture

You're referring to the €90bn of corporate bonds being purchased, and what the impact of this is on EU banks during a stressed scenario?  I'll preface by saying EU banks are woefully undercapitalized, but just want to ensure I am understanding your question correctly.

Countrybunkererd's picture

AHHH!  I can't rephrase it.  I have an issue and can't get out of it.  JUST WHEN IT IS GETTING GOOD!  If you can add to it I will check later tonight.

Justin Case's picture

The derivatives haven't gone away. They are just not discussed. They are still an overhang on the banking sector and their balance sheets and mark to fantacy. These will come to light at the most inconvenient time for the banks.

Countrybunkererd's picture

I think those in the industry don't understand insolvency.  when a bill can't be paid it doesn't matter if it is 10 bucks or 100 million bucks.

Winston Churchill's picture

You including derivatives in that statement, because so was Lehman until some couterparies failed.

I doubt even the banks know their real exposure is.

About time Tylers gave us a report on Shadow banking and where that stands.My phone has been ringing

constantly for the last month with people trying to lend me biz capital They sound almost desperate.

I'm sure its nothing though,cough,cough.

Chris88's picture

The whole bank derivative nonsense is another misunderstood nonsense, everyone looks at gross notional and not net payment required (and received) on the contingent events.  

Winston Churchill's picture

Didn't work that way for Lehman, so honest question;

Whats different this time ?

Chris88's picture

That's not why Lehman failed, they were comitting accounting fraud booking repurchases with relatively high rates as asset sales.  That was 1 of, oh I don't know, 20 fraud or borderline fraudulent things they did.  

Justin Case's picture

Lehman's high degree of leverage – the ratio of total assets to shareholders equity – was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns – the second-largest underwriter of mortgage-backed securities – Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the company returned to some extent in April, after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio.

Even though a bankruptcy examiner determined that Lehman Brothers withheld information about its leverage through accounting tricks, investigators could find little evidence of wrongdoing. The SEC is weighing issuing a report of its investigation that would focus on the company’s questionable actions, even if they were not proven to be illegal.

Much of the belief that Lehman Brothers acted illegally came from Anton Valukas, a court-appointed bankruptcy examiner. Valukas issued a 2010 report that sparked the SEC investigation, calling the actions of Lehman’s CEO Richard Fuld grossly negligent at the very least.

When Lehman Brothers collapsed, other brokerage firms selling their products also came under scrutiny. Many investors have said that the brokerages, like UBS Financial Services, should have known that the investments were riskier than advertised and failed their duty to their clients.

Chris88's picture

You're quoting investopedia, Lehman was one of our short positions leading into the crisis.  If you're telling me the bank was undercapitalized and MBS was marked incorrectly, you may as well tell me the sky was blue.  Anyone who wasn't a total retard knew that, the funds spoke amongst themselves at what a joke the company was before it fell.  As I said, there were many fraudulent (or borderline fraudulent) things they did, the insane assumptions going into many structured products they owned were batshit crazy and there were, at the time, at least active bid quotes so they could have very well been a level 2 asset but Lehman treated it like level 3. 

jcaz's picture

Uh, I was with Lehman, that's not what happened, Sparky- but thanks for playing.....

Oh I see- you were working in the money market department- my goodness, you ARE an expert then!

Chris88's picture

Your garbage company made me an amazing bonus in 2008, thank you.  Was your role at Lehman senior enough to know what was going on?  Or better question, were you with Lehman as they circled the drain or did you bail before?  

CrabbyR's picture

Just trying to decipher your comments, so net payments, hopefully not on a compounding balance should be managable?assuming the bets are on a good horse

Chris88's picture

Here, let me clarify something everybody is too stupid to get or too lazy to learn about.  Evil bank A has $600 trillion in gross notional derivatives, let's say, on 10 yr TSY futures for rate protection.  $290 trillion gross bets on them going up, $310 trillion going down.  The gross notional is a reference point, nobody owes anybody that.  Let's say the 10 yr moves up 20 bps, payments quarterly in arrears.  The bank is paid $580M on the long rte contract, and pays $620M, net loss is $40M (wow, so big huh?).  The reason a bank skews this, is likely because most are asset sensitive, so they benefit from rising rates.  The $40M derivative loss is likely offset to some degree by incrementally higher interest income, as deposit flight has not yet occurred as rates are already so low.  The real net loss is likely $10-$20M, this is for one of the world;s largest banks.  Get it?

Schmuck Raker's picture

Your saying there are no Evil Banks B that ever bet only $20T on one leg?(Using your example)

Chris88's picture

I have never seen one, the derivatives are used as risk management.  The risk deprtment at even a boutique, let alone bulge bracket, would never permit that to happen.  Speaking of bulge bracket, for a group that makes 60% +/- revenues in fee income, gets nearly free money from the Fed, why the hell would they risk imploding doing that even if the risk committee was OK with it?

Schmuck Raker's picture

First, thanks for your time Chris. Speaking to your question, "why would they risk it?", I can only answer with a rhetorical of my own: "Why have they in the past?"