Stress Test Results Positive For All Participating Banks

On Thursday, the Federal Reserve released the Dodd-Frank Act supervisory stress test 2017 (DFAST 2017) results, which, to a great extent, reflect the stability of the banking system. In fact, this reaffirms that the U.S. banking giants are adequately capitalized to survive under a tremendously difficult economic scenario.

All the bank holding companies (BHCs), including certain U.S. units of foreign banks with $50 billion or more in total consolidated assets, are part of DFAST 2017. All 34 BHCs, which submitted their capital plans to the Fed, passed the first round of test.

"This year's results show that, even during a severe recession, our large banks would remain well capitalized," Fed Gov. Jerome Powell said in a statement. "This would allow them to lend throughout the economic cycle, and support households and businesses when times are tough,” he further added.

Nevertheless, the clearance of the stress test does not automatically lead to the conclusion that the banks qualify for additional capital deployment. The banks will have to wait till Jun 28 for approval of their capital plans.

Overall Results

The Federal Reserve’s latest stress test scenario projections include input data supplied by the 34 banks participating in DFAST 2017, as well as models created by the regulatory staff and evaluated by a group of Fed economists and analysts. Moreover, the Fed's stress test was conducted to find out whether the banks have enough capital to survive another financial crisis, including a hypothetically 10% unemployment rate, more than 40% fall in stock prices, 35% drop in commercial real estate prices, more than 25% drop in housing prices, along with an economic downturn in developing Asia and a sharp rise in market volatility.

Additionally, severe recession in the UK, Europe and Japan was featured. The tests evaluate the losses expected for each bank with its capital.

Under the most severe scenario, the 34 banks would suffer $383 billion in loan losses, down from $526 billion in losses recorded by 33 banks in 2016. Notably, projected losses included $100 billion from credit card loans for the banks, at an equal level with commercial and industrial loans losses, for the first time. Therefore, both these categories constitute around 52% of the total projected loan losses worth $383 billion.

In aggregate, Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.5% in fourth-quarter 2016 to a post-stress level of 9.2% at the end of 2017. However, the figure is well above the 4.5% minimum mark set by regulators.

Notably, banks continuing with the annual stress test for seven years, included JPMorgan Chase & Company (NYSE:JPM) , Bank of America (NYSE:BAC) Corporation (NYSE:C) , Citigroup Inc. (NYSE:C) and Wells Fargo and Company (NYSE:WFC) . These four banks are the largest U.S. banks by assets. Among these, BofA and JPMorgan currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Further, as per the Dodd-Frank Act, bank holding companies participating in the Fed’s stress test rules have to conduct two company-run stress tests each year. In addition, these banks have to publicly unveil a summary of the results of the company-run stress tests conducted under the strictly adverse scenario given by the Fed.

Root of the Stress Test

Currently authorized under the Dodd-Frank financial-services law, the stress tests were introduced after the 2008 financial crisis. During this economic downturn, big financial institutions like Lehman Brothers collapsed and several other big banks were also on the verge of a collapse. Such a situation compelled the U.S. government to infuse billions of dollars into credit markets and save the entire financial system from failing. Stress tests have been annually conducted since 2009.

Recovery on the Way

This is not the final round. The big banks will have to undergo the Fed’s stress test once every year. This would help build up the weak capital levels of banks, which are always a threat to the economy. Also, this could ultimately translate to less involvement of the taxpayers’ money for bailing out troubled financial institutions.

Nevertheless, the approval from the Federal Reserve to increase dividend payment and accelerate the share buyback program will definitely help banks attract more investments, moving ahead. Thus, it can be said that the economy is on the right track to recovery.

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