Fed Unveils Dodd-Frank Stress Test Results

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WASHINGTON — Nearly three years after the Dodd-Frank Act imposed new capital testing requirements on the industry, the biggest financial companies received their first official report cards on Thursday.

The Federal Reserve Board released the initial round of results from stress tests required by the law on the portfolios of the 18 largest bank holding companies.

The tests — which precede separate results scheduled for next week that could have a meaningful impact on banks' plans for dividend payments — are meant to evaluate how well the firms' capital standing would hold up under a "severely adverse" economic scenario.

On the face of it, the results reflected the continually rising capital levels of the nation's largest banks since the financial crisis.

Leading the pack was Bank of New York Mellon, which emerged from the simulation with a minimum ratio of Tier 1 common capital to assets of 13.2%, the Fed said. The average ratio for the 18 firms was 7.4%, which is above the 6% threshold that regulators consider "well-capitalized." Only three banks — Morgan Stanley, Goldman Sachs and Ally Financial -- fell below that level, with the latter projected to hold just 1.5% capital in an adverse scenario.

Of the four biggest banks, three were relatively close to the well-capitalized threshold, with JPMorgan Chase projected to hold 6.3% capital in an adverse scenario, Bank of America to hold 6.8% and Wells Fargo to hold 7%. Citigroup, meanwhile, fared better, with a projection of 8.3%.

The central bank also included different categories of projected ratios under the test, including a Tier 1 leverage ratio and total risk-based capital ratio.

"Significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty," Fed Gov. Daniel Tarullo said in a press release.

The portfolios of the 18 firms — all with at least $50 billion in assets and together accounting for over 70% of the industry's assets — were tested under difficult economic conditions over a supposed nine-quarter period ending in the fourth quarter of 2014. The central bank highlighted what their extreme lowest ratios would be during that span. Senior Fed officials said the scenario assumed a two-year shock to the nation's economy not experienced since the worst of the Great Depression, with loss rates more extreme than the 2008-2009 financial crisis.

Still, all but one of the firms concluded the test with a minimum Tier 1 common ratio of at least 5%. (Morgan Stanley's ratio was 5.7% and Goldman's ratio was 5.8%.) The outlier was Ally Financial, with an unusually low Tier 1 common ratio of 1.5%. The Fed's report suggested Ally's results may be somewhat skewed as a result of the pending bankruptcy of its subsidiary Residential Capital.

BNY Mellon was followed by State Street at 12.8%, and American Express at 11.1%.

Immediate reactions from industry representatives were positive.

"The results of the Federal Reserve stress test reaffirm our position that retail banks are in a significantly better position today than in the past two decades," Richard Hunt, chief executive of the Consumer Bankers Association, said in a statement. "The capital increases over the past few years are not temporary, but permanent changes in our industry. Banks are significantly safer and sounder today and will be continue to be so in the future. Stress tests guarantee this and demonstrate our commitment to serving our customers."

The testing period began with what the firms' actual Tier 1 common ratios were in the third quarter of 2012, and then subjected their portfolios to various economic hypotheses to produce supposed ratio adjustments over the nine-quarter stretch. (Banks' capital standing was also put through tests assuming less severe conditions, but those results have not been disclosed.)

Yet the effects of the tests may not be as definitive as subsequent results expected to be released in a week.

On March 14, the Fed is expected to release stress test results based on the central bank's annual Comprehensive Capital Analysis and Review. The CCAR exercise, which predates Dodd-Frank and stems from regulators' original stress tests conducted during the turmoil of 2009, factors in the institutions' impending capital distribution plans through dividend payments and stock repurchases. Therefore, a bank's capital plan could effectively be approved or rejected by the central bank on the basis of its CCAR result.

The Dodd-Frank stress test results announced Thursday, meanwhile, simply assume the firms' capital distributions did not change. In essence, rather than amounting to a pass-or-fail exercise, some see the stress tests mandated under the law as a way to look comparatively at firms' potential vulnerability in an imagined crisis scenario.

"The stress tests are a tool to gauge the resiliency of the financial sector," Tarullo said.

The CCAR, which is conducted annually for the same companies, considers many of the same variables as the Dodd-Frank-required stress tests and evaluates the institutions' capital strength to support operations over the forthcoming two years.

Thursday's results were the latest installment of a whole host of stress test information disseminated since the crisis. Before the end of this month, the biggest firms are also expected to publicly disclose results from the first round of company-run stress tests required under Dodd-Frank. Longer-term, a wider scope of banks - those with over $10 billion of assets - are expected to announce stress test results under testing standards developed by their primary regulator.

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