Deutsche Bank AG's U.S. unit showed the greatest resilience against a severe economic downturn in this year's Federal Reserve stress test as European lenders outperformed their U.S. peers in terms of robustness of capital.

The U.S. subsidiaries of the other European banks included in the test — Barclays US LLC, BNP Paribas USA Inc., Credit Suisse Holdings (USA) Inc., HSBC North America Holdings Inc., Santander Holdings USA Inc., UBS Americas Holding LLC — were not far behind Deutsche Bank's DB USA Corp. arm in terms of projected minimum capital levels under stress.

The Fed annually tests U.S.-based banks with more than $100 billion in assets to ensure they have the capacity to keep lending in a severe recession. The Fed's severely adverse scenario in the 2022 stress test assumes a harsh global recession accompanied by a period of heightened stress in commercial real estate and corporate debt markets. The Fed typically adjusts the models used to determine the stressed conditions in the severely adverse scenario ahead of the annual test to reflect current market and macroeconomic projections.

The Fed published the most recent results on June 23. The U.S. subsidiaries of Deutsche Bank, Credit Suisse Group AG, Banco Santander SA, UBS Group AG and Barclays PLC were among the 10 best capitalized banks under a severely stressed scenario.

European strength

Deutsche Bank's strong performance can be attributed to its high common equity Tier 1 ratio of 26.7% at the start of the test, said Sonja Forster, vice president in DBRS Morningstar's global financial institutions team. A higher CET 1 ratio improves a bank's ability to withstand stress and reduces its risk of failure.

The unit's projected loan loss provisions under the adverse scenario were also lower than those of most other European bank subsidiaries, Foster said. The main driver was a lower projection for DB USA's provisions for losses on real estate assets, the analyst said, which bode well as the test's adverse scenario took into account sharp real estate price declines.

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With a projected minimum CET 1 ratio of 20.1% under stress, Credit Suisse Holdings (USA) was second best among the European bank subsidiaries and third best in the overall sample of 33 bank holding companies in the test.

Santander Holdings USA and UBS Americas followed, ranking fourth and fifth overall. Barclays US ranked ninth overall and fifth among the European cohort, while BNP Paribas USA ranked 17th overall and sixth among the European units.

HSBC North America Holdings lagged with a 7.7% projected CET1 minimum, ranking last among European bank subsidiaries and 28th in the overall sample.

A combination of weak revenues, high costs and loan loss provisions under the adverse scenario accounted for HSBC's result, said Maria Rivas, senior vice president at DBRS Morningstar's global financial institutions team. The unit has historically underperformed in stress tests, but its expense and provision levels were much improved this year. This demonstrated the progress achieved on costs, which was a key priority for the bank in 2021, Rivas said.

The median capitalization of European bank subsidiaries stood at 15.5%, well above the 9.7% figure for the full sample.

CET1 ratio deterioration

The majority of the European banks booked a higher rate of CET1 ratio deterioration than the sample median of 2.7 percentage points. Credit Suisse's unit booked the largest decline, of 7.5 percentage points, followed by HSBC's unit with 6.4 percentage points and BNP Paribas' with 4.2 percentage points.

This is a result of the banks' business mix and the design of the Fed exercise, DBRS Morningstar analysts said. The 2022 adverse scenario considered much higher increases in market volatility and corporate bond spreads than in the previous exercise. This made European bank subsidiaries — most of which are focused more on trading and capital markets than retail banking — particularly vulnerable, they said.

Santander Holdings USA was an outlier with an almost complete lack of CET1 ratio deterioration in the 2022 stress test. The bank stands out from its European peers due to its small trading operations and highly profitable auto-finance business, Santander Consumer USA Inc., said Mark Narron, senior director at Fitch Ratings' financial institutions group.

The auto finance business, in particular, is behind Santander Holdings USA's "very strong" pre-provision net revenue, or PPNR, relative to risk-weighted assets, Narron said. The auto business's net interest margin as of March 31 was "very robust" at 4.5%, while its loan loss provision coverage was 63% even under stress in the 2022 test, Narron said. "That's pretty manageable," he said.

Santander Holdings USA's overall coverage ratio in 2021 was strong at 150%, said Pablo Manzano, vice president at DBRS Morningstar's global financial institutions team. What also plays into the bank's favor is the fact that consumer lenders generally perform better than other categories of banks under the Fed's stress tests as these banks maintain a strong level of pre-provisioning profits under the adverse scenarios, Manzano said.

PPNR, which is the sum of a bank's net interest income and noninterest income less expenses before adjusting for loan loss provisions, is a measure used by the Fed for income statement projections in the stress test.

In the 2022 test, Santander Holdings USA had the highest PPNR among European bank under severely stressed scenario, at 7.3%. Barclays US followed with a PPNR of 6% and Credit Suisse Holdings USA ranked third with 4.9%. BNP Paribas and Deutsche Bank unit's showed the lowest positive PPNRs of 1.3% and 2.2%, respectively. HSBC's U.S. unit had a negative PPNR of 0.1%.