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Some banks to see higher capital requirements after Fed stress tests

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Some banks to see higher capital requirements after Fed stress tests

Some banks can expect higher regulatory capital requirements after the Federal Reserve's stress tests, which covered 23 banks this year.

Citigroup Inc., Capital One Financial Corp. and Citizens Financial Group Inc. are likely to face higher common equity Tier 1 (CET1) requirements based on the results of their stress tests, Jefferies analysts wrote in a June 28 note. Citi's implied CET1 minimum would be 12.3%, up from 12%; Capital One's would likely be 9.3%, up from 7.6%; and Citizens' is likely to be 8.5%, up from 7.9%.

Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co. and M&T Bank Corp. are likely to face lower requirements, the analysts added. The requirements are expected to stay the same for trust banks — Bank of New York Mellon Corp., Northern Trust Corp. and State Street Corp. — as well as for Charles Schwab Corp. and U.S. Bancorp.

Wedbush analysts gave a similar analysis of M&T, Citizens and U.S. Bancorp and wrote in a June 29 note that all three banks' current CET1 ratios have "significant cushions" above the estimated minimum required CET1 ratios based on current stress test results, leaving all three with capital flexibility.

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The test results, published June 28 by the Federal Reserve, showed smaller hypothetical losses compared with the year prior, bucking expectations that they would lead to broad upward pressure on capital standards. Banks' aggregate CET1 ratio fell by a maximum of 2.3% in the simulation, compared with a decline of 2.7% in 2022. The aggregate loan loss rate was 6.4%, flat with 2022.

The Fed expects banks to postpone disclosing planned capital actions and stress capital buffer requirements until after 4:30 p.m. ET on June 30.

The global systemically important banks, or G-SIBs, "benefited from improvements in unrealized securities gains/losses," such as accumulated other comprehensive income, "given the sharp decline in interest rates over the testing horizon," the Jefferies analysts wrote.

While all banks are comfortably above minimum capital requirements, there is likely to be limited capital return activity in the near term as banks wait for regulatory clarity about the Basel III endgame and the Fed's holistic capital review, they wrote.

The upcoming regulations will likely lead to higher capital requirements for all banks above $100 billion in assets, they wrote, adding that "many banks have already pulled back on capital return in preparation for potential increases in requirements."

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Bank Policy Institute Executive Vice President and Head of Research Francisco Covas said in a statement that the scenario in this year's stress test "surpasses the severity of any recession since World War II, including the global financial crisis of 2007-2009," and said, "the industry has just endured a real stress test."

"The stress test is now a capital regulation, albeit one that is calculated with almost no transparency and notice-and-comment process," Covas added.

Raymond James analysts compared the test to 2022's in a June 29 note, describing this year's as "more challenging."

Ian Katz, managing director at Capital Alpha Partners LLC, wrote in a June 28 note that the Fed Vice Chair for Supervision Michael Barr gave "small hints that the tests will get tougher."

"We think the results could be used by progressive Democrats to argue that the Fed is being too soft on banks," Katz added. "Some may ask how all the banks can get a regulatory thumbs-up when the industry just went through a period of turmoil. But the tests aren't an endorsement or pass-fail grade meant for public consumption like a beauty contest."

SNL ImageDownload a tear sheet to run a stress test on banks and thrifts.
Download a template to generate a bank's regulatory profile.
Download a template to view exhibits from the 2023 stress test results.

Part of the stress tests measured the impact of commercial real estate portfolios.

"The test's focus on commercial real estate shows that while large banks would experience heavy losses in the hypothetical scenario, they would still be able to continue lending," the Fed wrote. "The banks in this year's test hold roughly 20 percent of the office and downtown commercial real estate loans held by banks."

Piper Sandler analysts said in a June 28 note that results were dispersed among credit-sensitive banks, such as Citizens, though the analysts "consider the results overall better-than-expected and a win for the group. It's a long road ahead for new capital rules, but this strikes us as a good first chapter in a longer story."

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