Fed stress tests show 31 largest banks, including Banco Santander, meet capital targets

(Updated 10:35 a.m.) WASHINGTON – The Federal Reserve on Thursday said all 31 big banks, including U.S. units of Banco Santander SA, subject to its “stress test” have sufficient capital to absorb losses during a theoretical sharp and prolonged economic downturn.
The stress test exercise is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act and it’s the first time since the central bank started in 2009 that no firm fell below any of the main capital thresholds. Under the theoretical adverse scenario, Boston-based Santander Bank would maintain a Tier 1 capital ratio of 10.2 percent, surpassing the regulatory requirement of 5 percent.
Santander Holdings USA would also pass the regulatory requirements, maintaining a Tier 1 common ration of 7.9 percent.
Passing the stress test signals that banks could soon be permitted to return profits to investors by raising dividends or buying back shares, but not until a second round of results are released on Wednesday. The second round evaluates financial institutions’ internal controls, examining qualitative factors during a hypothetical adverse scenario.
The Wall Street Journal reports that the U.S. units of Banco Santander SA and Deutsche Bank AG are expected to fail the second round of testing, which could prevent them from paying dividends to their European parents.
Santander has already made some internal moves, including last week when it appointed Scott Powell, former J.P. Morgan Chase & Co. exec, to become CEO of Santander Holdings.
Other highlights
Goldman Sachs Group Inc. surpassed the 8 percent minimum for total risk-based capital by 0.1 percentage point, potentially restricting its room to return capital to shareholders.
The annual tests, using hypothetical scenarios that are not forecasts, are the cornerstone of the Fed’s efforts to prevent a repeat of the 2008 financial crisis and to gauge the ability of banks to withstand economic turmoil.
The largest U.S.-based banks “continue to build their capital levels and to strengthen their ability to lend to households and businesses during a period marked by severe recession and financial market volatility,” the Fed said in a statement Thursday.
The Fed uses the exams to prod lenders into building up capital buffers. Banks that don’t meet a second round of tests released next week may face restrictions in buying back stock and paying dividends.
This year’s results are being released as the Fed faces scrutiny from lawmakers critical of its supervision of the biggest banks. Fed Chair Janet Yellen countered the criticism, saying this week the central bank works hard to avoid the trap of “regulatory capture,” or the risk that bank examiners get too cozy with the firms they oversee.
Six largest
Bank of America Corp. was the only bank among the six largest to improve in every capital measure from its performance in last year’s test. Wells Fargo & Co. surpassed every minimum by at least 2 percentage points. Morgan Stanley’s ratio in three capital measures fell in a severely adverse scenario to within 1 percentage point of the required minimum.
Loan-loss estimates for the 31 banks totaled $490 billion under a hypothetical severely adverse scenario, down from $501 billion for the 30 banks tested last year. The losses include a $102.7 billion hit to trading. JPMorgan Chase & Co. would suffer the most from trading losses, estimated at $23.6 billion.
The heaviest damage was to consumer lending, with 39 percent of projected losses from such activity as mortgages and credit cards.
Adverse scenario
The adverse scenario assumes a weakening in global economic activity while domestic inflation spurs an increase in Treasury yields. Short-term rates would reach more than 2.5 percent in 2015 and 5.25 percent in 2017.
Banks also had to account for a mild, three-quarter U.S. recession starting in the last quarter of 2014, during which time real gross domestic product falls half a percent and unemployment rises above 7 percent, going on to reach 8 percent by the end of 2016.
Under the severely adverse conditions, stocks fall by 60 percent by the fourth quarter of 2015 and housing prices drop by about 25 percent. Unemployment peaks at 10 percent, gross domestic product declines by 4.5 percent and the price of oil rises to $110 per barrel. Long-term Treasury yields fall to 1 percent in the fourth quarter of 2014 and then rise slowly.
Second round
The first round of tests analyzes whether companies have enough capital to withstand nine quarters of stressful economic conditions. The second round, to be released March 11, assesses their ability to weather losses and still pay dividends, buy back stock or make acquisitions.
In the first round last year, Zions Bancorporation was the only one of 30 banks to come in below one of the Fed’s main capital thresholds.
In the second set, the capital plans of five banks didn’t pass muster. Citigroup Inc. and the U.S. units of Royal Bank of Scotland Group Plc, HSBC Holdings Plc and Citigroup Inc. fell short because of qualitative concerns about their processes. Zions was rejected as its capital fell below the minimum required.
Deutsche Bank AG’s U.S. unit was added to the list of banks required to undergo the tests for 2015, bringing the total to 31.
The severely adverse scenario this year included deep recessions in the euro area, U.K. and Japan, and “below-trend” growth in developing Asia, according to guidelines the Fed released in October.
Management actions
Banks can’t pass or fail the test released on Thursday, which doesn’t take into account management actions to preserve capital. In the tests to be released March 11, regulators will try to ensure those actions, such as dividend cuts, keep banks above a minimum Tier-1 common ratio of 5 percent over nine quarters in harsh economic scenarios.
Fed officials have cautioned that even banks that exceeded all the thresholds in Thursday’s test may still find their requests for higher payouts rejected next week if regulators find the quality of the planning is flawed. The scrutiny can extend to management, systems and boards of directors.

  • Staff writer Eli Sherman contributed to this report.
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