The Fed has released the results of its most recent Dodd-Frank Stress Tests. All US banks were expected to pass (and are likely to lift the amount of money they send to shareholders via dividends and buybacks) but as Bloomberg notes, eyes are on smaller banks, which may have better-than-anticipated results and capital plans.
As a reminder, in the severely adverse scenario, asset prices drop sharply in this scenario. Equity prices fall 65 percent by early 2019, accompanied by a surge in equity market volatility. The U.S. market volatility index (VIX) moves above 60 percent in the first half of 2018. Real estate prices also experience large declines, with house prices and commercial realestate prices falling 30 percent and 40 percent, respectively, by the third quarter of 2019... but notably all of these adverse shifts revert back to normal after a few years.
And sure enough, all 35 banks reviewed cleared the first hurdle of the Fed's stress tests.
The most severe hypothetical scenario projects $578 billion in total losses for the 35 participating bank holding companies during the nine quarters tested. The "severely adverse" scenario, the most stringent scenario yet used in the Board's stress tests, features a severe global recession with the U.S. unemployment rate rising by almost 6 percentage points to 10 percent, accompanied by a steepening Treasury yield curve.
The firms' aggregate common equity tier 1 capital ratio, which compares high-quality capital to risk-weighted assets, would fall from an actual level of 12.3 percent in the fourth quarter of 2017 to a minimum level of 7.9 percent in the hypothetical stress scenario. Since 2009, the 35 firms have added about $800 billion in common equity capital.
"Despite a tough scenario and other factors that affected this year's test, the capital levels of the firms after the hypothetical severe global recession are higher than the actual capital levels of large banks in the years leading up to the most recent recession," Vice Chairman Randal K. Quarles said.
In other words, according to the Fed's stress test, if stock prices drop 65% and VIX soars above 60, all 35 banks will be ok...
So after the financial crisis we learn that banks can now withstand any financial market collapse. Helpful.— GreekFire23 (@GreekFire23) June 21, 2018
Federal Reserve stress test results show Goldman Sachs had a minimum supplementary leverage ratio (SLR) of 3.1, just exceeding the required 3.0 minimum the Fed set for its annual capital plan review to be released next week. GS’s tested SLR was the lowest among participating banks; Morgan Stanley was next, at 3.3, followed by State Street at 3.7; those were the only banks below 4.0.
State Street was the closest to minimum on Equity Tier 1 Capital.
Summing it all up: The next time the market crashes by 65%, the Fed's "stress test" will be Exhibit A why there will be no taxpayer bailouts: they can all survive on their own.
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The Fed will announce the CCAR results next week.
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Things have not gone well for bank shareholders in the few months since The Fed's last Stress Test (and CCAR) results...as the stress test scenarios, released in February, were tougher than had been expected.
The 'big' US banks have dramatically underperformed the 'small' US banks.
For the US biggest banks, it has been ugly...
The picture for the world's biggest banks is even worse... down over 20%...
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But, but, but... fortress balance sheets? Rising yields and NIM? Volatility is back for trading revenues?
And perhaps most ironic of all - Fitch put Deutsche Bank on negative outlook at exactly the same time as The Fed passed everyone.