The Federal Reserve made minor changes to the stress test data of 30 banks that were released last Thursday.
According to the Fed, the changes to the banks’ minimum, post-stress Tier I common capital ratios, in a severely adverse scenario, were necessitated due to “inconsistencies in the treatment of the fourth quarter 2013 actual capital actions and assumptions about preferred and employee compensation-related issuance over the course of the planning horizon.”
Of the 30 firms, the correction was immaterial for 26 cases, but led to a 0.5% decline in one bank (American Express Company (NYSE:AXP)), a 0.2% decrease in another (HSBC North America Holdings) and a 0.3% increase at two firms (M&T Bank Corporation (NYSE:MTB) and Northern Trust Corporation (NASDAQ:NTRS)).
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The projected minimum tier 1 ratios are displayed in the table below.
The poor test result for Bank of America Corp (NYSE:BAC) compared to its peers in the biggest banks puts a cloud on its plans to return capital to shareholders, a factor that will be assessed by the Fed in a second round of data to be released later this week.
The Fed’s testing basis parameters appear to have been far more rigorous that what the banks themselves applied in internal stress tests, says a March 20, 2014, report by Credit Suisse analysts Moshe Orenbuch, Jill Glaser Shea and Craig Sieganthaler.
The stricter norms mean that the Fed would seek higher capital levels before allowing the banks to return capital through dividends or buybacks. The variance in norms applied to the tests primarily relates to the assumption of lower asset growth rates and higher losses on home equity loans without tax deductibility.
According to the Fed assumptions, in a severely adverse scenario, the aggregate tier 1 common ratio for these 30 firms would fall from an actual 11.5% in the third quarter of 2013 to a post-stress level of 7.8% in the fourth quarter of 2015, as per the graph below.