Bank Stress Test Results [ANALYSIS]

Stress Test results for 18 large financial institutions were released by Federal Reserve. The stress test evaluated the capital adequacy of bank holding companies (BHC)’s in a stressed scenario. Importantly, 17 BHC’s passed” the stress test. The post-stress Tier 1 common ratio is at 7.7% on a median basis which comes in well above the 5% minimum established by the Fed. This compares to consensus estimates of 7.8% Basel 1 Tier 1 common ratio heading into the results.

The most notable difference with the Fed’s stress test results versus estimates is lower pre-provision net revenue for the capital-markets sensitive names. The Fed’s estimate of stressed PPNR for the 18 BHCs was $268 billion came in $30 billion lower than estimates of $298 billion. PPNR of $268 billion is net of losses related to operational risk events and mortgage repurchases, as well as expenses related to disposition of owned real estate of $101 billion.

Total stressed losses of $563 billion, including losses related to operational risk of $101 billion compares to estimates of $600 billion heading into the stress test. Specifically, the adverse stress scenario produced $462 billion of 2-year cumulative losses across loan portfolios, investment securities portfolios, trading and counterparty losses from the global market shocks and other losses.

The Fed’s losses came in $40 billion lower than estimates of $502 billion driven by loan losses that were $12 billion lower and trading losses that were $24 billion lower than estimates. The loss content that the banks are positioned to withstand should also increase confidence in the sector. It highlights the extent to which the industry has recapitalized, reduced risk and improved overall balance sheet strength.

Based on the Fed’s analysis, the industry has about $200 billion in excess capital above the 5% minimum even in a stress scenario which comes in line with estimates. This should provide incremental confidence about capital deployment capacity and highlight the extent to which the industry has recapitalized, reduced risk and improved overall balance sheet strength.

Total provision expense was $317 billion versus estimates of $329 billion. Overall loan losses came in lower than estimates and cumulative stressed loan losses declined to 7.5% from 8.1% last year. The 2-year loss estimated on first lien mortgages declined modestly to 6.6% (from 7.3% last year), but more notably, the 2-year loss rate assigned to second/junior lien mortgages declined to 9.6% from 13.2% last year.

On the commercial side, the loss rate on CRE increased to 8.0% from 5.2% last year, while the loss rate on C&I declined to 6.8% from 8.2% last year.

Large Banks

Moshe Orenbuch, an analyst at Credit Suisse Group AG (NYSE:CS) believes that the results of the 2013 stress test prove that the Fed stressed PPNR more rigorously for those banks with trading operations. Among large cap banks covered by CS, this resulted in $27 billion worse PPNR than their forecast (including losses related to operational risk which are deducted from PPNR).

PNC Financial Services (NYSE:PNC), Citigroup Inc. (NYSE:C) and U.S. Bancorp (NYSE:USB) capital ratios fared the best under the adverse stress scenario. PNC’s stressed Tier 1 common ratio came in 90 bps higher than forecasts as a result of lower losses and slightly higher PPNR. However, the company has already indicated that they did not request share buyback this year as they work towards Basel III compliance. Citi’s stressed Tier 1 common ratio came in about 40 bps better than forecast, with modestly higher PPNR, but substantially lower losses and provisions than expected. The company announced its capital plan request to the Fed with a flat dividend and $1.2 billion of share repurchase in 2013.

CS had expected an increase in the dividend and $1.0 billion of share repurchase. U.S. Bancorp (NYSE:USB)’s stressed Tier 1 common ratio was 90 bps better than CS forecasts, largely as a result of better PPNR. Bank of America’s stressed Tier 1 common ratio came in 60 bps better than their estimate despite lower PPNR which was offset by lower losses than CS forecasts (both loan and trading losses). Wells Fargo & Company (NYSE:WFC) stressed Tier 1 common ratio came in at 7.0% relative to their estimate of 7.6% given lower PPNR and higher provision expense.

Howard Chen who covers US brokers for CS notes that both Goldman Sachs and Morgan Stanley passed this year’s stress test, though both companies fared somewhat less favorably than anticipated— he does not believe this will impact CS 2013 capital return assumptions (Goldman Sachs Group, Inc. (NYSE:GS): 70-75% divided between buyback & dividends, Morgan Stanley (NYSE:MS): 100% buy-in of MSSB). CS attributes the lower stressed ratios to the inclusion of Basel 2.5 market risk rules (300-400 bps hit to Basel I ratios) in the CCAR planning horizon, the impact of the global market shock scenario and in the case of Morgan Stanley, lower pre-provision net revenues/higher operational risk measures.

Specifically, Tier 1 Common ratio under the severely adverse scenario for Goldman Sachs Group, Inc. (NYSE:GS) of 5.8% was stable from last year’s level, while Tier 1 Common for Morgan Stanley (NYSE:MS) improved to 5.7% from 5.4%. Pre-provision net revenues for Morgan Stanley were $1.2 billion, a modest improvement from $1.0 billion last year despite what we believe to be a vastly improved operating environment, more stable franchise positioning and less in the way of one-time items. For Goldman Sachs, pre-provision of $14.4 billion was also modestly improved from $14.2 billion during last year’s stress test. Also interesting to note and difficult for us to explain for Goldman Sachs was a staggering 49.5% C&I loss rate that drove an estimated $1.4 billion of loan losses off of the firm’s modest loan portfolio.

Finally, Fed results came in short of both Goldman Sachs Group, Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS) projections that were also released earlier this evening. Specifically, GS anticipated the firm’s stressed PPNR to be $20.4 billion (actual: $14.4 billion) with a minimum T1C of 8.6% (5.8%). MS expected its stressed PPNR to be $6.3 billion (compared to $1.2 billion) with a minimum Tier 1 Common ratio of 6.7% (5.7%). Modeling differences aside, CS partially attributes the wide disparity in forecasts to the volatility of historical earnings and differing operational risk assumptions (these were embedded within the Fed’s PPNR assumption).

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