This year marked the first time that regional banks were allowed to sit out the Federal Reserve’s annual stress testing exercise, and most opted to do just that.
But four companies — Regions Financial in Birmingham, Alabama, MUFG Americas Holdings in New York and the U.S. arms of Toronto-based Royal Bank of Canada and BMO Financial — all opted in, and their decisions could pay off for their shareholders.
The companies easily passed this year’s tests and, as a result, their stress capital buffers — that extra layer of cushion the Fed required of the largest banks last year during the pandemic — could be lowered, freeing them to return more of the capital to shareholders in the form of dividends or stock buybacks.
“One of the motives” for opting in to the stress tests “is to improve the stress capital buffer,” said Scott Siefers, managing director and senior research analyst at Piper Sandler.
Banks with assets between $100 billion and $250 billion are now stress tested every other year and this year marked the first time banks not scheduled to be tested could voluntarily opt in.
Regions, BMO Financial, RBC and MUFG declined to comment before the results were released. But David Turner, chief financial officer of the $153.3 billion-asset Regions, said on an April 23 earnings call that the company was opting in because executives were confident the upcoming results would bear out proof that the bank can handle a lower stress capital buffer.
“This gives an opportunity for an independent third party, in this case, the Federal Reserve, to show everybody what our losses are relative to peers,” Turner said during the earnings call. “So we're excited about participating. We think it will show well.”
The foreign-owned companies, meanwhile, may have opted to prove to the Fed that they are as safe and sound as any domestic bank holding company, Siefers said.
“For domestically owned subsidiaries of foreign banks, there’s been a perception that it’s sort of a high hurdle for them,” Siefers said. “They’re showing the Fed that they have infrastructure in place that’s as good as anything else out there.”
Each bank’s current capital buffer is based on last year’s stress test. The buffer is the difference between a bank’s capital level as the “severely adverse” scenario under the stress tests began and where it was projected to end up, taking into consideration what the banks planned to pay out in dividends.
The lower the stress capital buffer, the better the bank is seen to have performed under the stress test, with the minimum being 2.5%. The Fed
Several banks, including Regions and BMO, asked that the tests and their stress capital buffers be reconsidered. The Fed dismissed the objections in October and
Regions was assigned a 3% stress capital buffer. The Fed required a 6% buffer for BMO, 4.4% for MUFG and 3.6% for RBC. Each was higher than most of their peers.
The Fed’s stress test covers the period ending in the first quarter of 2023. It in part measures how much a bank’s common equity Tier 1 ratio deteriorates under a severe downturn. This plays a key role in how the Fed calculates what higher stress capital buffers the banks are required to hold.
A smaller deterioration in the CET1 ratio in this year’s stress test compared to last year’s is a key indicator of how much in losses a bank can absorb and whether it will have its stress capital buffers lowered.
Regions’ CET1 ratio fell by about 1 percentage point from 9.8% to a minimum of 8.9% under the severe adverse scenario, according to Thursday’s results. That difference narrowed from a 2.4 percentage point drop during last year’s test.
BMO’s ratio fell by 3 percentage points to a bottom of 9.5%, compared with a nearly 6 percentage point decline in last year’s results.
MUFG’s ratio fell by 3.4 percentage points to a low of 11.9%, which is a smaller drop than the 4.4 percentage point decline last year.
RBC’s CET1 ratio also decreased by 3.4 percentage points to 12.4%, which is slightly smaller than the 3.6 percentage point fall during last year’s stress test.
The results suggest that the stress capital buffers for all four banks could be lowered when the Federal Reserve announces later in the year where the requirements will be set.
BMO appealed its stress test results last year after its common equity Tier 1 ratio fell to 5.4% under the severely adverse scenario, the lowest among the 33 firms graded at the time.
The company said that it disagreed with the Fed’s calculations for noninterest income and noninterest expenses and believed objecting to the grades could lead to a lower stress capital buffer requirement. Analysts had wondered if the bank’s restructuring effort at the time skewed the results.
But the Fed dismissed the appeal, leaving the company to opt in to another shot at improving its results this year.
The companies that opted out were Ally Financial, Citizens Financial Group, Fifth Third Bancorp, Huntington Bancshares, KeyCorp, M&T Bank Corp., the credit card giants American Express and Discover Financial and the U.S. units of BNP Paribas and Santander Holdings USA.
Each of the banks that opted out declined to say why. For some, there may have been little incentive because their capital buffers are already low or have no intentions to pay out dividends or buy back stock. For instance, M&T has said it did not plan to repurchase shares again until its
“Unless you have a company specific factor, it’s unclear to me exactly what the upside is to doing so,” Siefers said. “If you’re already at a low capital buffer, you’re probably having unofficial conversations with the Fed anyway. No need to open up a box that could have some negative surprise.”
