A bank stress test, also called a Comprehensive Capital Analysis and Review (CCAR), is an evaluation of the financial fitness of the largest U.S. financial institutions by the Federal Reserve. The test determines if the banks have sufficient capital buffers to withstand economic recession and market turmoil. In the words of the Federal Reserve:
“The Comprehensive Capital Analysis and Review (CCAR) is a supervisory assessment by the Federal Reserve of the capital planning processes and capital adequacy of these large, complex bank holding companies (BHCs). The CCAR is the Federal Reserve’s central mechanism for developing supervisory assessments of capital adequacy at these firms.”
The test uses two macroeconomic scenarios to plot a ‘What If?‘ scenario: one based on baseline conditions; the other with more pessimistic expectations. Banking institutions are assessed based on their Tier 1 common capital, which is the core measure of a bank’s financial strength from a regulator’s point of view. Tier 1 common capital is core capital, comprised primarily of common stock and disclosed reserves (or retained earnings), but may also include non-redeemable non-cumulative preferred stock.
The Fed’s first bank stress test was conducted in 2009 on 19 bank-holding companies, only 9 of which were found to have adequate capital. The other 10 were judged to require additional capital in varying amounts, from $1.1 billion to, in the case of Bank of America, $33.9 billion!
The Federal Reserve recently undertook another bank stress test of 19 financial institutions, which gives the lie to the media’s propaganda of an economic recovery.
The stress test results were published on Tuesday, March 13, 2012, in a report titled “Comprehensive Capital Analysis and Review 2012: Methodology and Results for Stress Scenario Projections.” To read the report in pdf, click here.
Here are the stress test results (quotes in italics are from the report):
1. The maximum losses of the 19 banks in the test are projected to hit a total of $534 billion:
“The results of the stress scenario projections suggest that the 19 BHCs (bank holding companies) as a group would experience significant losses under the assumptions of the Supervisory Stress Scenario. Losses at the 19 BHCs are projected to total $534 billion over the nine quarters of the scenario, including losses across the loan portfolios, trading and counterparty credit losses from the global financial market shock, and losses on securities held in the BHCs’ investment portfolios. Losses related to operational risk events such as fraud, computer systems failure, and employee lawsuits, and losses related to mortgage repurchases, which are included in pre-provision net revenue (PPNR), add another $115 billion to this total. Projected PPNR at the 19 BHCs is $294 billion over the nine quarters of the scenario. Together, the high projected losses and low projected PPNR result in projected net income before taxes of $222 billion for the 19 BHCs. This is an extremely low level of net income relative to historical experience in the U.S. banking industry, even in periods of considerable economic and financial market stress.”
2. Four banks flunked the stress test: Ally, SunTrust, Citigroup, MetLife (Any bank with a “tier 1 common ratio” below 5% fails the stress test):
“Despite sometimes significant projected decreases, most of the BHCs maintain stressed regulatory capital ratios including all planned capital distributions above regulatory minimum levels over the course of the stress scenario horizon. Overall, 4 of the 19 BHCs have one or more projected regulatory capital ratios (including capital distributions) that fall below regulatory minimum levels at some point over the stress scenario horizon, including 3 BHCs with a stressed ratio of tier 1 common ratio below the 5 percent benchmark established in the capital plans rule. In interpreting these results, it is important to recall that the Federal Reserve’s stress scenario projections are deliberately stringent and conservative assessments under hypothetical, adverse economic conditions and the results are not forecasts or the most likely outcomes for these BHCs.
The minimum levels for BHCs to be considered adequately capitalized are 4 percent for the tier 1 ratio, 8 percent for the total capital ratio, and 3 or 4 percent for the tier 1 leverage ratio. Based on the U.S. capital adequacy guidelines, the tier 1 leverage minimum is 3 percent for BHCs with a composite BOPEC rating of “1″ and for BHCs that have implemented the Board’s risk-based capital measure for market risk. The tier 1 leverage minimum is 4 percent for all other BHCs. The tier 1 leverage ratio minimum is 4 percent for Ally Financial Inc., American Express Company, Capital One Financial Corporation, and MetLife, Inc., and 3 percent for the rest of the 19 BHCs participating in CCAR 2012. The capital plans rule further stipulates that the BHCs must demonstrate their ability to maintain tier 1 common ratios above 5 percent.”
Four banks with tier 1 common ratios at or below the prescribed 5% are:
- Ally Financial Inc. 2.5%
- Sun Trust Bank, Inc. 4.8%
- Citigroup Inc. 4.9%
- Metlife, Inc. 5.1%
Here’s Table 3 on page 25 of the stress test report, showing the four banks that are at risk, :
~Click table to enlarge~
More on what the Fed’s Supervisory Stress Scenario (that is, the projected worst case scenario for the U.S. economy) looks like tomorrow!
H/t Tyler Durden for ZeroHedge
~Eowyn
