Stress tests offer room for regional banks

The first round of this year's Fed-supervised bank stress tests highlights the relative resilience of U.S. regional and custody banks in a severe economic stress scenario. The largest trading and universal banks, on the other hand, will likely face constraints in pursuing more aggressive capital distribution plans in part because of severe market shock assumptions employed in the tests, according to Fitch.

The Fed-administered tests, which analyze the ability of 18 large U.S. financial institutions to absorb severe economic and market pressure in a hypothetical adverse scenario, support the view that most banks' capital and liquidity positions are sufficiently strong to incur heavy losses in their loan and trading books over a prolonged period (nine quarters). Of the institutions reviewed, only Ally Financial failed to maintain a Tier 1 capital ratio above 5%, after stresses were applied through the end of 2014.

Importantly, the first review assumes that all institutions maintain dividends at existing levels and that no additional capital actions (dividend increases or share repurchases) take place. Related results from the Comprehensive Capital Adequacy Review (CCAR) tests, which factor in banks' planned capital actions, will be released on March 14. Based on the results of the first round of Dodd-Frank tests, we expect all institutions except Ally to meet the Fed's minimum capital requirements for the CCAR. This is supported by the fact that banks are able to resubmit their capital plans after reviewing first-round results.

Large regional and custodial banks saw less significant declines in projected Tier 1 capital ratios by year-end 2014 under the severely adverse scenario. Regional institutions, including BB&T, PNC, US Bancorp and Fifth Third, all maintained capital ratios above 7% at the end of 2014 under the severe stress assumptions. Custodial banks, including State Street and Bank of New York Mellon, fared best among all institutions in terms of capital levels and projected losses.

The relative strength of these institutions reflects the smaller size of their trading operations and what appears to be relatively harsh market risk scenarios applied to the trading and derivative books of the largest U.S. institutions. Global rating agency Fitch believes the projected riskbased capital ratios for the largest trading banks were affected significantly by the much higher risk-weighted assets assumed under Market Risk Capital Rule implemented Jan. 1, 2013.