Fitch: US Bank Stress Tests Highlight Improving Resilience

CHICAGO & LONDON--(BUSINESS WIRE)-- The first stage of this year's US bank stress tests highlights improving resilience with solid results despite a severely harsher scenario that included a more severe downturn than previous tests and negative short-term US Treasury rates, Fitch Ratings says. All 33 US bank holding companies passed the minimum capital ratio requirements. Tested firms overall generally performed better, posting higher capital ratios and smaller declines in capital ratios than in the past.

The largest global banks generally performed better than last year, although they still account for over half of projected losses under the severely adverse scenario, since they are subject to global market shock and counterparty default component. Pre-provision net revenue (PPNR) projections were noticeably higher this cycle, particularly for the five largest global trading and universal banks - Goldman Sachs, JP Morgan, Morgan Stanley, Citigroup and Bank of America. This more than offset higher losses from the stress scenario and may mean that some large global firms that typically revised capital plans post-DFAST won't do so this year.

The test hit Morgan Stanley hardest in terms of capital erosion, although very high starting risk-weighted capital ratios gives it greater flexibility. It is more constrained by the leverage ratio, which had a projected minimum of 4.9%, leaving only a 90bp cushion above the requirement.

Among other weaker performers, two firms in the midst of M&A performed significantly worse than last year. Capital ratios for Huntington Bancshares may have taken a hit from the pending FirstMerit acquisition, resulting in a projected minimum common equity tier 1 (CET1) ratio of 5% - the lowest of all 33 banks. The First Niagara merger may be a key driver for the erosion of KeyCorp's CET1 ratio to minimum 6.4%. These banks and others close to the 4.5% CET1 minimum threshold may constrain their capital return requests.

For firms that fared well quantitatively, the threat of a capital plan rejection for qualitative reasons under the second stage - Comprehensive Capital Adequacy Review (CCAR) - is still a significant hurdle. Modeling negative interest rates is likely to be more challenging for regional banks than global banks, like Citigroup, that already operate in markets with negative rates. The qualitative assessment may also bring up issues for new participants. Both are foreign-owned banks, which historically haven't performed as well in the CCAR.

Credit card issuers and trust and processing banks performed well with the least capital erosion. However, their pre-provision net revenue projections were down compared to 2015, probably because of negative rate assumptions depressing interest income, which particularly impacts processing banks. Bank of New York Mellon and State Street's PPNR projections fell around 20%-30%. Still, as in previous cycles, these firms showed projected net income over the nine quarters of the stress horizon, in contrast to net losses for firms with other business models.

Negative rates also had more impact on regional banks. The Fed said that firms more focused on traditional lending activities were more affected by this assumption.

Almost three quarters of the $526 billion in losses projected under the severely adverse scenario stemmed from loans, while 21% arose from trading and counterparty positions subject to the global market shock and counterparty default component. Projected loan loss rates varied significantly from 3.2% on domestic first lien mortgages to 13.4% on credit cards. The loss rate for domestic commercial real estate loans improved by 160bp to 7%, the first rise since 2012. The rate for commercial and industrial (C&I) loans deteriorated, jumping 90bp to 6.3%. C&I loan growth has been strong and the weaker performance may reflect energy sector weakness within these portfolios.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Source: Fitch Ratings

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