The Federal Reserve announced today that it has rejected the capital plans for five of the 30 bank holding companies (BHC) that took part in its most recent stress test (the other 25 can proceed as planned). The rejection of Zions Bancorporation (NASDAQ:ZION)’s capital plans was already a given. As the only BHC to fail the stress test it will have to resubmit and either reduce its risk exposure or increase its tier 1 capital (or both) and then submit new capital plans. With just one bank for the Fed to focus on, some analysts are worried that process could become painful for Zions and its shareholders.
Four more banks’ capital plans get rejected
But the other four banks, Citigroup Inc (NYSE:C), HSBC Holdings plc (ADR) (NYSE:HSBC) (LON:HSBA), RBS Citizens Financial Group Inc., and Banco Santander, S.A. (ADR) (NYSE:SAN), had all passed the stress test, so the rejection of their capital plans is more of a surprise. These four BHCs didn’t have the worst stress test results (RBS Citizens was well above the average tier 1 capital ratio under severe adverse circumstances), so the capital plans must have been relatively ambitious for these four banks.
Banks have doubled tier 1 equity ratio since 2009
“U.S. firms have substantially increased their capital since the first set of government stress tests in 2009,” says the Fed report. The aggregate tier 1 common equity ratio has increased from 5.5% in 1Q2009 to 11.6% in 4Q2013 while aggregate tier 1 common equity has grown from $511 billion to $971 billion. “That trend is expected to continue,” the report states.
The Fed stated that it rejected the other four capital plans for qualitative reasons. Considering that, of the 30 BHCs, 28 are expected to continue building capital through the rest of this year, it sounds like Citigroup Inc. (NYSE:C), HSBC Holdings plc (ADR) (NYSE:HSBC) (LON:HSBA), RBS Citizens Financial Group Inc., and Banco Santander, S.A. (ADR) (NYSE:SAN) may have felt that their capital ratios were sufficient to level off this year, and the Fed simply felt otherwise.
Difference between Fed results, in-house estimates may be to blame
This was also the first year that the Fed used independent balance sheet projections, and the results were markedly different for some banks. Citigroup Inc. (NYSE:C) in particular had a 7% tier 1 capital ratio under the Fed stress test, compared to 10% using in-house estimates. So it’s also possible that even if the banks’ capital plans were conservative using their own estimates, they may have been too ambitious after the fact. As Citi and others get used to the way that the Fed conducts these tests (which are still evolving), the learning curve for setting acceptable capital plans should level off.