The U.S. Federal Reserve recently published the Comprehensive Capital Analysis and Review (CCAR) 2014 Summary Instructions and Guidance. The CCAR, commonly known as the bank “stress test”, is required for all 30 bank holding companies (BHCs) with total consolidated assets greater than $50 billion.
According to a report from Credit Suisse Securities Research, the framework, timing and disclosure of the stress test are very similar to last year’s. There are, however, a number of changes to the variables in the supervisory adverse scenario, which is likely to cause projected losses somewhat larger than those produced in the 2013 CCAR process. The Federal Reserve is anticipating releasing the results by March 31, 2014.
Stress test: Severely adverse conditions scenario more onerous
The main reason the 2014 CCAR is likely to result in greater projected losses (and thus the need for greater capital reserves) for banks is that the seriously adverse conditions scenario has been toughened up to reflect an even more extreme economic slowdown, including significant housing price declines. The 2014 CCAR severely adverse stress test scenario uses a 25% peak to trough decline in home prices compared to the around 20% decline used in CCAR ’13.
Big bank average capital positioning improved by 18%
The Credit Suisse report also notes, however, that the capital position of the big banks has improved by 18% on average, which will blunt the need to increase capitalization. The large banks reported free capital of $355 billion more than the Basel III Tier 1 common minimum of 4%, or 18% year-over-year vs the minimum 5% Basel I standard in effect in 2013.
2014 CCAR should not have a significant negative impact on performance
The overall conclusion of the report is that although Credit Suisse Group AG (ADR) (NYSE:CS) sees big banks as overall “well positioned”, they also anticipate that the more stringent 2014 CCAR will cause “capital distributions relative to earnings to remain somewhat conservative.”
In terms of specific equities in the sector, Credit Suisse Group AG (ADR) (NYSE:CS) suggests taking a look at Citigroup Inc (NYSE:C) and PNC Financial Services Group, Inc (NYSE:PNC), which they anticipate will demonstrate the most greatest improvement in capital returns over the next few quarters.
