A stressful condition is an assumed scenario where equity prices tumble more than 50 percent, employment rate crosses 12.1 percent and home prices drop 20 percent
Morgan Stanley (NYSE:MS) and Goldman Sachs Group Inc. (NYSE:GS) executives could be worried because the Federal Reserve may raise concerns if the two bank giants try to increase their dividends or share buybacks in 2013. The central bank estimates that under a stress scenario, the Tier One common ratio of Goldman Sachs Group Inc. (NYSE:GS) may fall to 5.8 percent in 2014. Morgan Stanley’s same ratio could drop to 5.7 percent in a stressful scenario.
Tier One is the ratio of common equity to overall assets. Banks are required to have Tier One common ratio of at least 5 percent to engage in share buybacks or dividend payments. Goldman’s ratio was at 13.1 percent in Q3 of 2012, while Morgan Stanley (NYSE:MS)’s ratio stood at 13.9 percent in the same period.
Estimates under stressed scenarios for these two banks are based on their share buyback and dividend plans for the last year. Since their estimated capital ratios are above 5 percent, the Fed is unlikely to ask them to cut back on their capital distributions. Financial groups that have submitted aggressive distribution plans may be asked to submit a revised version if their proposed distribution brings down their capital ratios below 5 percent.
According to the Fed, a stressful condition is an assumed scenario where equity prices tumble more than 50 percent, employment rate crosses 12.1 percent and home prices drop 20 percent.
The capital distribution plans submitted to the Federal Reserve haven’t been made public. The approved capital plans will be announced next week. The Fed had instructed banks not to disclose whether or not their distribution plans have been approved before the next week’s formal announcement. Eighteen banks participated in the exercise, and almost all of them are expected to pass.
Apart from Goldman Sachs Group Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS), Ally FinancialInc. (NYSE:GMA) is the only bank whose capital ratios would drop below 6 percent in a stressful 2014. Ally Financial Inc. (NYSE:GMA)’s Tier One common ratio could go down to as low as 1.5 percent, the stress test results show. So, it’s no eligible for a capital distribution.
The Fed said that banks are now better prepared to weather any financial shocks. Here is what the capital ratios of various banks will look like under a stressed situation in 2014:
- Wells Fargo & Co. (NYSE:WFC): 7 percent
- U.S. Bancorp (NYSE:USB): 8.3 percent
- SunTrust Banks Inc. (NYSE:STI): 7.3 percent
- State Street Corp. (NYSE:STT): 12.8 percent
- Regions Financial Corp. (NYSE:RF): 7.5 percent
- PNC Financial Services (NYSE:PNC): 8.7 percent
- KeyCorp (NYSE:KEY): 8 percent
- Fifth Third Bancorp (NASDAQ:FITB): 8.6 percent
- BB&T Corp. (NYSE:BBT): 9.4 percent
- Bank of New York Mellon Corp. (NYSE:BK): 13.2 percent
- Citigroup Inc. (NYSE:C): 8.3 percent
- Bank of America Corp. (NYSE:BAC): 6.8 percent
- JPMorgan Chase & Co. (NYSE:JPM): 6.3 percent
However, analysts raised questions on stress tests, saying that the Fed has been too lenient in the tests. The tests didn’t consider what would happen if a major financial institution collapsed, and the central bank also underestimated potential losses. “The stress tests were just not very stressful,” said Rebel A. Cole, a finance professor at DePaul University.