The big picture on the annual stress tests is that large and regional banks could absorb a nasty downturn. But a closer look at the results reveals some tidbits that are worth watching.
Some banks got mildly disappointing news, which will weigh on their ability to please their investors by buying back shares. A couple of others did better than expected. The worries over banks' commercial real estate loans appear to have been a bit more bark than bite — at least at the 31 big and regional banks that were tested.
And the country's largest bank, JPMorgan Chase, said its own numbers suggest the Fed mildly overstated the bank's strong footing.
The latest Federal Reserve tests showed that banks would stay resilient under a severe hypothetical recession. They'd absorb heavy losses of $685 billion, driven by credit card losses and commercial loans, but the Fed says they'd have enough of a cushion to withstand them.
"The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario. This test shows that they do," Fed Vice Chair for Supervision Michael Barr said in a news release, even as he also noted that banks performed worse than last year due to riskier balance sheets and increased expenses.
Bank analysts agree that the tests showed the industry could withstand a brutal downturn. Still, they noted, this year's stress tests had more negative surprises for individual banks than positive ones.
Analysts expect banks to start providing information on Friday about how much excess capital they plan to return to shareholders via dividends or buybacks. But they also note that the banks' plans hinge on what happens to the Fed's pending proposal to raise capital requirements on banks.
The Fed appears poised to soften its proposal after facing massive industry pushback, but the final outcome is far from clear.
"We may not see an overall pickup in buybacks until economic and regulatory uncertainty abates," Wedbush Securities analyst David Chiaverini wrote in a note to clients.
Citi looks like a winner
The numbers are still being finalized, but Citigroup appears to be the only megabank whose capital requirements will go down.
The bank's revenues stayed strong during the hypothetical scenario, Wolfe Research analyst Steven Chubak wrote in a note to clients. That should lead to a mild decrease in the stress capital buffer that Citi is required to hold to guard against loan losses, while the comparable buffers at JPMorgan Chase, Bank of America and Wells Fargo are due to rise a bit, Chubak wrote.
Citi's positive surprise "was an encouraging result," given that the Fed cited credit card defaults as a major factor driving this year's stress test losses, he wrote.
Like other banks, Citi would see significant losses from its credit card portfolio, with nearly 17% of its card portfolio experiencing losses under the Fed's "severely adverse" scenario. But that figure was better than the 17.6% median at the 31 banks the Fed tested.
Citi's improvement this year could free up some $3 billion in capital that it could use to buy back shares, Bank of America analyst Ebrahim Poonawala wrote in a note to clients. It also helps boost investor hopes that Citi may achieve the return-on-equity targets that have long eluded the bank — a top priority for CEO Jane Fraser as her turnaround attempt continues.
Poonawala expects Citigroup's stress capital buffer to drop by 30 basis points. Among those that will see a bump-up to their SCB, Goldman Sachs stands out with a roughly 100 basis point increase, Poonawala noted, writing that it's a "near-term negative for our bullish investment thesis" on the Wall Street investment bank.
Among regional banks, Huntington Bancshares in Columbus, Ohio, will see a significant 70 basis point decline in its stress capital buffer, Poonawala wrote. M&T Bank in Buffalo, New York, and Truist Financial in Charlotte, North Carolina, should also see declines, while Citizens Financial Group in Providence, Rhode Island, will see a 60 basis point increase, he added.
Scott Siefers, a Piper Sandler analyst, wrote in a note to clients he had hoped Citizens "could experience some relief from its elevated requirements." But the opposite happened, he wrote, explaining that the culprit appears to be lower revenues during a recession, rather than severe credit losses.
"We have some trouble understanding why this negative result has come to pass, but we were clearly incorrect in our more bullish aspirations through this year's test," Siefers wrote.
JPMorgan says its results were a bit too rosy
Banks tend to avoid disagreeing when regulators say their capital requirements should be lower.
But JPMorgan Chase released a statement just before midnight Wednesday doing just that. The country's biggest bank had reviewed the Fed's projections for its "other comprehensive income," a line item that includes unrealized gains and losses from banks' bond portfolios.
Since the Fed's stress scenario envisioned interest rates falling sharply, banks would see the value of their existing bonds rise.
JPMorgan, however, said that the benefit the Fed projected for the bank's other comprehensive income "appears to be too large."
"Should the firm's analysis be correct, the resulting stress losses would be modestly higher than those disclosed by the Federal Reserve," the bank said in a news release.
JPMorgan was also sure to remind investors that its capital cushion is far above regulators' requirements, giving it ample room to absorb those modestly higher losses.
The New York megabank noted that its Common Equity Tier 1 capital ratio was 15% at the end of March, well above the 11.9% it's required to hold. That accounts for some $54 billion in excess capital, the bank said.
BMO would absorb the most severe losses
The bank that suffered the most severe losses in the stress tests was the U.S. division of Canada's Bank of Montreal.
Its capital cushion was 10.5% at the end of last year. But the Fed's stress scenario would sharply lower its buffers against loan losses, with its CET1 ratio falling as low as 5%.
While that's above the 4.5% that regulators require BMO to hold, its stressed capital ratio was the lowest of all the banks the Fed tested. The next lowest was a significant distance away: Citizens Financial with 6.5%.
In a statement, BMO said it is well capitalized, with a CET1 ratio of 10.9% at the end of March.
"The Federal Reserve's stress test demonstrated BMO Financial Corp.'s ability to maintain capital ratios above minimum requirements, even in a highly stressed scenario," the company said.
Under the stress test's assumptions about a severe recession, the bank would suffer losses of $3.8 billion on its commercial loans, $2.8 billion on commercial real estate loans and $1.2 billion in non-credit card consumer credit, such as auto loans.
While BMO had enough capital to absorb those losses, the Fed projected that it would make less money than most other banks and thus add less to its capital cushion during a downturn.
Credit cards were again a drag
Losses from credit card loans once again weighed heavily on the banks' performances, accounting for a quarter of all losses under the stress tests.
The Fed projected that banks would absorb some $175 billion in credit card losses under the severely adverse scenario, or 17.6% of their current balances.
Credit card balances
Delinquency rates have also been rising from their unusually low levels during the pandemic, when many consumers were saving more money, and they got a boost from government stimulus funds. The Fed noted in its stress-test report that the borrowing increase followed the "depletion of pandemic-era savings."
A few credit card companies' stock prices closed down a bit on Thursday, with Capital One Financial falling 2%, Discover Financial Services sliding 1.29% and Synchrony Financial losing 1.49%.
But analysts weren't overly worried about the credit card picture. Regional banks generally don't have large credit card portfolios, some analysts noted, and the lenders that do focus on credit cards have
Recent data shows "stabilization" in the prevalence of credit card borrowers falling behind on their payments, according to Moshe Orenbuch, who analyzes consumer finance companies at TD Cowen.
The growth in credit card balances has also ebbed as "spending growth has significantly moderated," Orenbuch wrote in a note to clients. And consumer-focused banks are "still noticeably above" regulators' required capital levels, he noted.
Is CRE actually … fine?
The dominant fear among bank investors has involved commercial real estate loans, with some observers foreseeing major pain as some office buildings sit empty and multifamily landlords struggle with higher costs.
Most of the banks with the largest CRE concentrations, which typically have less than $100 billion of assets, were not part of the Fed's stress tests. But the results in CRE for big and regional banks were notably not so bad.
The Fed noted that while projected losses for office properties rose, they were offset by a decline in losses for hotel and retail property loans. In all, the stress-tested banks would experience losses on 8.8% of their CRE portfolios, the same percentage as last year, according to the Fed.
"A stable CRE loss rate may be viewed somewhat positively given the notable regulatory and market focus," analysts at Raymond James wrote in a note to clients.
In contrast, loss rates on banks' business loans rose from 6.7% last year to 8.1% this year. The increase was surprising, and it
