Annual Stress Test: 23 Largest U.S. Banks Passed Severe Recession Scenario

All 23 U.S. banks involved in the annual stress test by the Federal Reserve have weathered a severe recession scenario while continuing to lend to consumers and corporations, the regulator announced on Wednesday. The banks managed to maintain a minimum capital level despite projected losses of $541 billion for the group, while continuing to extend credit to the economy in a hypothetical recession, the Fed stated in a release.

Initiated after the 2008 financial crisis, partly caused by irresponsible banks, the Fed’s annual stress test dictates how much capital the industry can return to shareholders through buybacks and dividends. In this year’s exam, banks underwent a ‘severe global recession’ with unemployment rising to ten percent, a 40 percent decline in commercial real estate values, and a 38 percent drop in property prices.

Indeed, U.S. banks are under increased scrutiny in the weeks following the collapse of three mid-sized banks earlier this year. The test examines giants including JPMorgan Chase and Wells Fargo, international banks with significant operations in the U.S., and the largest regional players including PNC and Truist.

However, just because the banks passed the testing does not mean that real problems do not exist, as has been the case in previous years. In the coming months, heightened regulations for regional banks are expected due to recent bankruptcies, as well as stricter international standards that will likely increase capital requirements for the largest banks in the country.

– Today’s results confirm that the banking system remains strong and resilient. At the same time, this stress test is just one way to measure that strength. We should remain humble regarding potential risks and continue to work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses – said Michael Barr, Vice Chairman for Supervision at the Fed, in a statement.

Credit Cards Most Problematic

Credit losses accounted for 78 percent of the $541 billion in projected losses, with most of the remainder coming from trading losses at Wall Street firms, the Fed said. The overall loss rate on loans varied significantly among banks, from a low of 1.3 percent at Charles Schwab to 14.7 percent at Capital One.

Credit cards were the most problematic credit product in the test. The average loss rate for cards in the group was 17.4 percent; the next worst average loss rate was for commercial real estate loans at 8.8 percent. Among card issuers, Goldman Sachs’ portfolio recorded a loss rate of nearly 25 percent in the hypothetical downturn (the highest for any individual loan category among the 23 banks), followed by Capital One’s rate of 22 percent.

Rising losses in Goldman’s consumer division in recent years, driven by credit card loan reserves, have forced CEO David Solomon to pivot away from his strategy of serving consumers, CNBC reported.

Regional Banks in a Bind?

The group recorded a decline in total capital levels from 12.4 percent to 10.1 percent during the hypothetical recession, but that average masked larger hits to capital seen in banks that are more exposed to commercial real estate and credit card loans. Regional banks including American Bank, Truist, Citizens, M&T, and Capital One focused on cards had the lowest stress capital levels in the test, ranging from six to eight percent.

Although still above current standards, these relatively low levels could be a significant factor if upcoming regulation forces the industry to hold higher capital levels.

Large banks generally performed better than regional and card companies, wrote Jefferies analyst Ken Usdin in a research note on Wednesday. Capital One, Citigroup, Citizens, and Truist could see the largest increases in required capital reserves after the test, he wrote.

Banks are expected to announce updated plans for buybacks and dividends on Friday after the close of regular trading. Given the uncertainties surrounding upcoming regulation and the risk of a real recession coming next year, analysts say banks will likely be relatively conservative with their capital plans, CNBC reports.