Banks’ Split With Fed on Stress Test Seen Risking PayoutsDakin Campbell, Elizabeth Dexheimer and Michael J. Moore
Goldman Sachs Group Inc., Citigroup Inc. and Bank of America Corp. staked out sharply divergent views from the Federal Reserve on how they’d fare in a market shock, clouding prospects for higher payouts to shareholders.
The split came as lenders and regulators each released their versions of stress-test results yesterday, with Goldman Sachs predicting that its Tier 1 common ratio would be about 3.8 percentage points stronger than Fed estimated in a worst-case scenario. New York-based Citigroup calculated a ratio almost 3 percentage points better than the central bank.
The disputed figure measures a firm’s ability to absorb losses, and discrepancies can lead the Fed to reject plans for higher dividends and stock buybacks.
“If one of those companies had a fairly wide disparity between its own model and the Fed’s model, that’s going to raise red flags,” Todd Hagerman, an analyst at Sterne Agee & Leach Inc. in New York, said in a phone interview. A big gap could spur regulators to question the quality of the bank’s capital planning, Hagerman said.
The first round of the Fed’s annual stress test measures how well banks can weather economic turmoil, before the regulator signals in a second stage whether firms can proceed with proposed dividends and buybacks.
While the central bank’s figures showed that 29 of the 30 largest U.S. lenders could withstand a deep recession, Fed officials have said the decision will include subjective judgments about management, processes and boards of directors. That announcement is set for March 26.
“Qualitative relates to quality -- if the Fed sees anything funky in the capital plans, they reserve the right to send them back to the drawing board,” Nancy Bush, a bank analyst who founded NAB Research LLC in New Jersey, said in a phone interview. “That’s healthy.”
The Fed today revised capital ratios in its results after finding “inconsistencies” in parts of how the test was administered. Eric Kollig, a Fed spokesman, declined to elaborate beyond the central bank’s statement.
Last year, banks whose figures differed most from the Fed’s -- Goldman Sachs and JPMorgan Chase & Co. -- were forced to submit new capital plans to address weaknesses in their processes. The New York-based firms were allowed to continue payouts in the meantime. Fed officials said this week their expectations of lenders will rise each year.
This year, JPMorgan virtually matched the Fed’s projection for its Tier 1 common ratio, differing by only 0.2 percentage point. Bank of America’s figure was more optimistic than the Fed’s by about 2.7 percentage points. Morgan Stanley’s gap was 2 percentage points and Wells Fargo & Co.’s was about 1.4 percentage points.
“There is some possibility that BAC may have to resubmit its capital-return request,” Moshe Orenbuch, an analyst at Credit Suisse Group AG, wrote in a research note, referring to Bank of America’s stock symbol.
Spokesmen for all six lenders declined to comment. While the regulator posted results for every bank in this year’s first round, not all of them released their own calculations yesterday for comparison.
Analysts estimate that the 23 publicly traded banks in this year’s tests can afford to pay out more than $75 billion in excess capital to investors if the Fed approves.
The stress tests are designed to prevent a repeat of the 2008 financial crisis, when the banking system teetered near collapse and the U.S. created a $700 billion taxpayer-funded bailout program. Firms in this year’s tests must describe what would happen to capital ratios, revenue and loss rates on various assets in dire scenarios described by the Fed.
Eight of the biggest banks also must demonstrate they can handle the sudden demise of their trading partner with the potential for greatest losses.
Yesterday’s results show big U.S. banks “are collectively better-positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago,” the Fed said in a statement. “This result reflects continued broad improvement in their capital positions since the financial crisis.”
The central bank tested firms under two scenarios. Its “adverse” case gauges what would happen to the value of their existing holdings of riskier commercial loans should yields rise as high as 9.2 percent in this year’s third quarter. In the Fed’s “severely adverse” environment, the unemployment rate peaks at 11.25 percent, stocks fall almost 50 percent and U.S. housing prices slide 25 percent, while the euro area sinks into recession.
Each party uses its own model to produce estimates of losses and capital ratios, which can vary. “Because we employ models and methodologies developed by us, our results will differ, potentially significantly, from projections that the Federal Reserve will make,” San Francisco-based Wells Fargo, the largest U.S. mortgage lender, wrote in a presentation of its figures.
The Fed’s assumptions are so conservative that the banks’ findings can be more realistic in some cases, said R. Scott Siefers, a managing director at Sandler O’Neill & Partners LP in New York. While a “huge gap” could affect next week’s results, many things can determine whether banks win approval, he said in an interview.
Zions Bancorporation was the only lender projected by the Fed to fall below one of the main capital thresholds. The Salt Lake City-based firm’s Tier 1 common ratio would drop to as low as 3.6 percent in a severely adverse scenario, short of the 5 percent minimum used when approving capital plans in the test’s second stage, the Fed said.
Zions, which is participating in the stress tests for the first time, said earlier this year that it will refile its capital plan because a sale of some securities cut risk. Yesterday, the firm said the next submission also will include additional actions to ensure it meets the Fed’s requirements.
Shares of Zions fell 5.3 percent to $31.24 in New York, the worst showing in the 24-company KBW Bank Index, which dropped 0.3 percent. Bank of America declined 2 percent.
Among the six largest U.S. lenders, Bank of America and Morgan Stanley slid closest to the regulatory minimum across the five ratios being tested.
The Fed found that Charlotte, North Carolina-based Bank of America’s Tier 1 leverage ratio could fall to about 4.6 percent under the “severely adverse” scenario. The same ratio at Morgan Stanley would drop to around 4.7 percent. The regulatory minimum stands at 4 percent.
Such close margins don’t necessarily mean a firm’s capital plan is in jeopardy. Goldman Sachs analysts led by Richard Ramsden said in a note today that the tests showed banks had $90 billion of excess capital, and were likely to seek approval to return less than half that amount.
Bank of America’s more-than $2.1 trillion in average total assets at the end of last year indicate it could return about $13 billion to investors without falling below the leverage threshold. The lender, which ranks as the nation’s second-largest bank, may have requested a buyback over the next year and a dividend increase for the next two years that total $10 billion, Keith Horowitz, an analyst at Citigroup, said in a note to investors yesterday.
Morgan Stanley’s more-than $830 billion of total assets show it can return almost $6 billion before falling below the minimum. The New York-based firm, which owns the world’s biggest brokerage, may have asked to return $2.1 billion, the analysts’ estimates show.
Smaller lenders also differed with the Fed. Capital One Financial Corp. estimated its Tier 1 common capital ratio would fall no lower than 10.4 percent, better than the central bank’s projection of about 7.8 percent.
Some almost matched the Fed’s projections, with Minneapolis-based U.S. Bancorp, the nation’s biggest regional lender, posting a minimum ratio of 8.5 percent, 0.3 percentage point higher than the central bank. PNC Financial Services Group Inc. estimated its ratio at 9.6 percent, 0.6 percentage point above the Fed’s mark.
BB&T Corp., which had to revise its capital plan last year to win approval, produced estimates this time that were even more conservative than the Fed’s. The Winston-Salem, North Carolina-based bank said the Tier 1 common ratio could fall to 6.8 percent, compared with the central bank’s 8.4 percent estimate.
Next week, the banks also must show what capital levels would look like after taking into account their plans for acquisitions, higher dividends and stock buybacks.
“The financial system is safe and strong and the capital base is growing,” said Dan Ryan, head of PricewaterhouseCoopers LLP’s financial-regulation practice. “The average person who relies on the banking system should be happy. Next week will tell us whether banks and bank shareholders will be happy.”
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