The Federal Reserve released its report on the latest bout of stress tests on the banks (NYSE:XLF), (NYSE:IYF). The stress tests are supposed to show whether certain banks can handle a recessionary environment or if they are too weak. This is mostly decided by capital reserves and tangible assets which the bank can pull from in dire times.
The stress scenario that was tested on banks had an unemployment rate of 13%, 50% drop in equities, and a 21% decline in housing prices. The nineteen banks that were tested in this scenario showed losses to be around $534 billion over the course of nine quarters of deep recession. The tier 1 capital ratio (stable capital to risk capital) showed a decline from 10.1% in Q3 of 2011 to 6.3% in 4Q of 2013.
However, the good news is that in that worst case scenario test with a tier 1 ratio of 6.3%, it still beat the actual tier 1 from tests conducted in 2009. This shows us that banks have gotten stronger over the years and have raised enough capital to weather a possible recession.
The actual stress tests results concluded that 15 of the 19 banks passed the test. However, the results are a bit skewed because the Fed’s stress tests take a very conservative approach to its hypothetical economic conditions. We do not know how the banks would actually hold up in that kind of environment if there were other factors at play. Bottom line, the more capital a bank has in its reserves and less risky assets, the more likely they will be to survive any economic conditions.
According to CNBC, it is confirmed that the four banks that failed the stress test are Citi (C), MetLife (MET), Ally (ALLY), and SunTrust (STI). Which means that American Express (AXP), The Bank of New York Mellon Corp (BNY), BB&T (BBT), Goldman Sachs (GS), JP Morgan (JPM), Keycorp (KEY), Morgan Stanley (MS), Regions Financial (RF), US Bancorp (USB), Wells Fargo (WFC), Bank of America (BAC), Capital One (COF), Fifth Third Bancorp, PNC Financial and State Street passed the Federal Reserve’s stress tests.
It should be mentioned that this is a leaked report and that the Fed expects to officially release the report on Thursday. However, as of right now this is the most updated information on the issue.
We think that it is surprising that Bank of America and JP Morgan passed the tests. Both of these banks have had a hard time getting their businesses back on track, BofA more so. As for Citi and the other three, this is a wake up call that they need to start raising more capital and trimming risky assets. There is no excuse to not getting your books and assets in order now. This is a huge warning and if these banks fail to adhere to the results, they could be facing difficulties if our fragile recovery stalls.