Results of the Federal Reserve’s Supervisory Stress Tests showed the resiliency of the 23 banks, with capital remaining well above required minimums and in line with expectations, Fitch Ratings says. We expect increased capital distributions following similar results of the last two stress test rounds, with higher capital returns beginning to reduce absolute capital levels, subject to the stress capital buffer (SCB) framework. However, risk-weighted assets are not expected to meaningfully grow, which could support higher distributions.
Under the severely adverse scenario, collectively the CET1 ratio declined from 13.0% at 4Q20 to a minimum of 10.6% before rising to 11.2% at the end of 1Q23, remaining well above the 4.5% required minimum. Of note, Goldman Sachs and Morgan Stanley had outsized capital erosion relative to their GTUB peers. Performance of large regionals (excluding Wells Fargo) improved under this scenario from the last two stress tests. Capital One showed the most improvement of super-regional peers, driven by high pre-provision net revenue and reserve levels and lower card balances as a percentage of loans. The trust and processing banks had the least capital erosion overall.
Banks were projected to have $474 billion in aggregate losses under the severely adverse scenario. Credit cards loans were projected to account for 19% of losses (down from 25% in the December tests) and may have been even lower, notwithstanding the Fed’s model adjustment. C&I loans also were estimated at 19% of total losses, with commercial real estate (CRE) at 14%. Elevated CRE loan losses reflect the overhang from the economic fallout of the pandemic, particularly for those asset classes such offices and hotels that have been most directly impacted.
The severely adverse scenario included a global recession that stressed CRE and corporate debt markets, saw a 4% rise in unemployment rates to 10.75%, a 4% downturn in GDP, and a 55% decline in equity prices. The 2021 adjustments model for the stress tests included probability of default for auto loans and credit card accounts, loss-given default for CRE loans backed by hotel properties and the calculation of payment status for first lien mortgages. The Fed continues to project that loans collateralized by hotels in markets with extraordinarily high vacancy rates would experience losses, reflecting significantly lower recovery rates relative to historical averages.
In aggregate, the SLR ratio declined from 7.7% at 4Q20 to a minimum of 5.5%, above the 3.0% required minimum, under the severely adverse scenario. Banks tested with the least headroom in excess of the minimum included HSBC NA with an SLR of 3.3% and Goldman at 3.9%. However, some banks may become more constrained by the SLR capital requirements versus CET1, which through a combination of actions such as issuance of preferred stock, retain more capital through lower capital returns, slow lending growth or reduce excess deposits.
Source: Fitch Ratings