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Most Banks Pass Stress Test, But With Lower Than Expected Margin

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While 29 out of 30 bank holding companies passed the Federal Reserve’s most recent stress tests (maintaining at least 5% tier 1 capital ratio in the severe adverse scenario), and Zions Bancorporation (NASDAQ:ZION) already has plans to resubmit, the Fed’s estimates came in well below what many banks had projected when conducting internal stress tests.

Fed switched to independent projections this year

“Several banks have released their own stressed capital ratios under severely adverse scenario,” write Credit Suisse analysts Moshe Orenbuch, Jill Glaser Shea and Craig Sieganthaler in a March 20 report. “The most relevant variance from expectations was at Bank of America, where the minimum stressed ratio under the Fed’s scenario of 6.0% compared to our estimate of 7.5% (adjusted) and the firm calculation of 8.6%.”

The Fed decided to use independent balance sheet and RWA projections this time around so that the results would be more consistent and easier to compare, but it seems that it made very different assumptions than most of the banks participating in the stress test. Specifically, it assumed lower asset growth rates and higher losses on home equity loans without tax deductibility. Citigroup Inc. (NYSE:C) had a comparable gap, a 7.0% minimum according to Fed calculations but a 10.0% minimum in the company-run stress test.

Even though Bank of America Corp (NYSE:BAC), Citigroup Inc. (NYSE:C), and others passed the stress tests, having a lower estimated minimum restricts the amount of capital return that the banks can request. Considering the gap between the two estimates, some of the banks may need to alter their plans for returning capital or resubmit after reducing their debt exposure.

Stress test: Zions will resubmit to reflect CDO sales

Zions Bancorporation, the only BHC to fail the stress test with a minimum tier 1 common ratio of 3.5% under the severe adverse scenario, will resubmit to include the sale of collateralized debt obligations in January and February that reduces its risk exposure. Zions said that the reason the Fed’s estimates were much worse than its own projections were due to “significantly higher commercial real estate losses, significantly greater risk-weighted assets, and lower pre-tax, pre-provision net revenue.”

Even knowing the harsher assumptions that the Fed us using to make its estimates, Zions Bancorporation (NASDAQ:ZION) is confident that the CDO sales and “additional actions that will further reduce risk and/or increase its common equity capital” will be enough for the bank to maintain a 5% minimum tier 1 common ratio when it resubmits.

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Michael Ide
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