The results of the latest stress test were very much at odds with the expectations of some of the bond analysts, credit rating agencies, the banks themselves and the investors in general. However, the regulator was satisfied that the bank holding companies have continued to improve their ability to withstand an extremely adverse economic crisis. The post-stress capital ratios for the 18 bank companies under consideration exceeded the aggregate Tier 1 common capital ratio of 5.6% at the end of 2008. I believe Goldman Sachs is best positioned to return a high level of capital, while Citigroup has the largest cushion to survive a prolonged crisis.
This time around the Fed tested on the following scenarios:
- U.S. unemployment peaks at 12.1%
- U.S. equity prices fall over half their prices
- U.S. home prices fall over 20%
The above hypothetical scenarios were assumed to prevail for at least nine quarters.
Overall results show projected losses of $462 billion within the 18 bank holding companies put under stress tests. Besides, the aggregate Tier 1 common capital ratio is expected to fall from its third quarter of 2012 actual 11.1% to 7.7% in the fourth quarter of 2014. The results specific to each bank are shown in the following table.
Projected Q4 Tier 1
common capital ratio (%)
Net Income Before Taxes ($ Bn)
Bank of America
Source: The Federal Reserve
It is evident from the table above that among the money center banks, Citigroup (C) is projected to have the highest post-stress capital ratio of 8.9%, meaning it has the largest cushion. Its third-quarter tier 1 common capital ratio was 12.7%, up 230 bps from JPMorgan's (NYSE: JPM) ratio. Therefore, Citigroup appears to be the safest bank in the U.S. Citigroup's third-quarter tier 1 common capital ratio was 40 bps below the ratio of Goldman Sachs (NYSE: GS) and significantly below the 13.9% ratio of Morgan Stanley (NYSE: MS). Citigroup is also expected to post a loss of $28.6 billion during the period the hypothetical crisis prevails.
The above tests were conducted based on Basel 1 capital ratios, which the Fed intends to replace with Basel 3 regulations. Basel 3 regulations are considered more stringent. Under Basel 3, Citigroup estimates its capital ratio to be 8.6%, 20 bps above JPMorgan's estimate of 8.4%. Basel 3 will not treat deferred tax assets for the bank holding companies as favorably as did Basel 1. This is one reason why Citigroup's tier 1 common capital ratio fell under Basel 3.
Wells Faro (NYSE: WFC), Goldman Sachs and Morgan Stanley estimated their Basel 3 capital ratios at 8.02%, 8.5% and 9%, respectively. Therefore, if the Basel 3 regulations were implemented and the tests were conducted based on it, Morgan Stanley would have clearly been the safest bank.
What To Expect On March 14
March 14, is the date when the Fed will disclose whether capital plans submitted by the bank holding companies will be approved or not. Credit Suisse in a report to its investors says that it expects a median dividend payout ratio of 24%. In total, it expects capital deployment activities to increase from 36% to 63%. Much of the improvement in capital deployment will be driven by buybacks.
Among the money center banks considered in this investment thesis, Goldman Sachs is best positioned and most likely to return a high level of capital (72%) as a percentage of estimated 2013 earnings. JPMorgan and Wells Fargo are expected provide a healthy rate of capital return of 71% and 59%, respectively. Bank of America, Morgan Stanley and Citigroup are expected to pay out 14%, 10% and 9%, respectively.
Additional disclosure: The article has been written by Equity Whisper's Financials Analyst. Equity Whisper is not receiving compensation for it (other than from Seeking Alpha). Equity Whisper has no business relationship with any company whose stock is mentioned in this article.