Fed Broadening Stress Tests to Include 11 More Banks

WASHINGTON — The Federal Reserve Board will be expanding its yearly stress-test exercise next year to include 11 more bank holding companies, bringing the total to 29 firms.

Comerica (CMA), Huntington Bancshares (HBAN), M&T Bank (MTB), Northern Trust (NTRS), Discover Financial Services (DFS) and Zions Bancorp. (ZION) are among the bank holding companies set to join the 18 others now required to participate in annual examinations that test banks' capital strength in times of stress.

The others, all U.S. subsidiaries of foreign companies, are BBVA USA Bancshares, BMO Harris, Citizens Financial Group, HSBC North America Holdings, and UnionBanCal.

All of the firms have undergone a smaller-scale stress test by the Fed over the past two years, known as the Capital Plan Review, or CapPR. That test, which is considered to be far less rigorous, does not use the Fed's models. While regulators do weigh in on bank's capital distributions, that information is not released publicly as under the Comprehensive Capital Analysis and Review, or CCAR, process.

"This year will capture everyone that was part of the CapPR," said John Moran, a bank analyst for Macquarie Research, of the upcoming March exam.

Instead, "they had run a dual-track system, where the bigger guys went through full-blown CCAR, and the smaller guys that were still over $50 billion went through CapPR," said Moran. "This year they are shifting everybody to go through full-blown CCAR."

The banks have widely expected to be swept up in the Fed's stress test-process, and have been gradually readying themselves by spending heavily on additional staff and outside consultants to help them prepare for the exercise.

The $56 billion-asset Huntington, for example, is budgeting roughly $10 million for regulatory expenses this year and Chairman and Chief Executive Stephen Steinour said that "quite a bit of that was related to CCAR preparations."

Rene Jones, the chief financial officer at the $83.5 billion-asset M&T, said that because management is unfamiliar with the Fed's modeling, the bank is devoting more resources to CCAR preparation "to make sure we're pretty well-positioned to go through that test for the first time."

Discover Chief Executive David Nelms says that while becoming a CCAR bank "certainly raises the bar" for the firm, he is not worried about being unprepared.

"There's one additional case that we will have to run that we didn't have to run before," said Nelms in an interview Tuesday. "But we are very confident that we are going to be well-positioned to sort of meet all the requirements."

Additional scrutiny from the regulators comes with the territory of having $50 billion or more of assets. All institutions that meet that threshold will also have to undergo a separate stress test exercise required under the Dodd-Frank Act and they must meet a slew of additional regulatory requirements, including adhering to Basel III standards and submitting drafts of living wills.

Graduating to the Fed's CCAR stress test is not a surprise to these firms. All were notified at the end last year's exercise they would need to start transitioning to more robust planning to be ready for 2014. (In the fall, the Fed is expected to announce plans to end its Capital Plan Review exercise.)

The Fed has indicated since the "beginning this would be a gradual process where more and more institutions would be moving over into stress-test scenarios," said Patrick Sims, a senior analyst with Hamilton Place Strategies.

At a Fed board meeting in July, Fed Gov. Daniel Tarullo mentioned the central bank's plan to broaden its stress testing and capital plan review program, saying that the central bank plans to extend its exercise to a "dozen or so banking organizations with greater than $50 billion in assets that have not been fully covered in the exercises we have undertaken since 2009."

In earnings conference calls this month, bank executives fielded numerous questions about the impact the more stringent stress test will have on their bottom lines.

Zions' Chief Financial Officer Doyle Arnold said that his $54.7 billion-asset company has spent "a little over $3 million in the second quarter" hiring consultants in order to "get up to so-called CCAR standards."

"We would expect continued similar amounts at least through the next couple of quarters, and then begin to taper off, probably in [the] middle of 2014, depending on the results of our CCAR stress test at the end of this year," said Arnold.

Northern Trust's chief financial officer, Michael O'Grady said that the $97 billion-asset company also faced a "higher level of consulting expenses in the quarter," roughly $6 million, as it continues its transition from being a "CapPR bank" to being a "CCAR bank."

"There's no question that we are in this transition period," said O'Grady. "I just can't predict whether there will be future transition periods. But this year, there's no question that there are a number of either transitions like that or first time projects, like resolution planning that just didn't exist in the past, but require both internal and external resources."

The stress tests are designed not just to evaluate banks' capital strength, but also to give regulators a better view of banks' overall risk management practices.

Discover's Nelms says that while the bank has a "strong capital position going, relative to other players… that alone isn't sufficient. There's an awful lot of process points and things that one needs to do, and we're putting those resources on it that are required to do well."

Last March, JPMorgan Chase (JPM), Goldman Sachs (GS) and BB&T (BBT) all learned that lesson firsthand. All three scored well on the test, holding capital above the minimum 5% Tier 1 common ratio even in a "severely adverse" economic scenario. But they were criticized by the Fed, which said they did not effectively estimate how a particular risk might affect their portfolio and were told to draft new capital plans as a result.

The regulatory goal for such exercises, says Hamilton Place Strategies' Sims, "is ultimately looking at risk management inside banks" especially during a prolonged period of low interest rates. "That's really what they're getting at — is to better understand the risks and what they're exposed to."

Marty Mosby, an analyst with Guggenheim Securities, agrees that banks need to be thoroughly examining their risk management processes now to ensure they are not criticized by regulators later.

"They're going to have to make sure there is really a risk management process with a robustness to it that enables it to be able to meet the standards of the biggest banks," he says.

Kevin Wack contributed to this story.