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Fed Tells U.S. Banks to Test Capital Against Recession Scenario
Feb. 17 (Bloomberg) -- The Federal Reserve ordered the 19 largest U.S. banks
to test their capital levels against a scenario of renewed recession with
unemployment rising above 11 percent, said two people with knowledge of the
review.
The banks stress-tested the performance of their loans, securities, earnings
, and capital against at least three possible economic outcomes as part of a
broader capital-planning exercise. The banks, including some seeking to
increase dividends cut during the financial crisis, submitted their plans
last month. The Fed will finish its review in March.
“They’re essentially saying, ‘Before you start returning capital to
shareholders, let’s make sure banks’ capital bases are strong enough to
withstand a double-dip scenario,’ ” said Jonathan Hatcher, a credit
strategist specializing in banks at New York-based Jefferies Group Inc.
Regulators don’t want to see banks “come crawling back for help later,”
he said.
Executives at banks such as JPMorgan Chase & Co. in New York and PNC
Financial Services Group Inc. in Pittsburgh have asked regulators for
permission to increase dividends. The Fed has told banks that it expects
dividends and share buybacks to be “conservative” and allow for “
significant accretion of capital,” according to a November notice. Some
capital payout plans may be rejected as “inappropriate,” the notice said.
The review “allows our supervisors to compare the progress made by each
firm in developing a rigorous internal analysis of its capital needs, with
its own idiosyncratic characteristics and risks, as well as to see how the
firms would fare under a standardized adverse scenario developed by our
economists,” Fed Governor Daniel Tarullo said in an e-mail.
Dodd-Frank Act
The Fed also wants banks to consider how the Dodd-Frank Act overhauling
financial oversight might affect earnings, and how they will meet stricter
international capital guidelines, according to the November notice. Banks
will also have to consider how many faulty mortgages investors may ask them
to take back into their portfolios. Standard & Poor’s Corp. estimates
mortgage buybacks could cost the industry as much as $60 billion.
The Fed’s adverse economic scenario included a 1.5 percent decline in gross
domestic product from the fourth quarter of last year through the end of
2011, said the people, who declined to be named because the Fed hasn’t made
the details of the review public. The scenario assumed growth resumes, with
output rising 4 percent over the fourth-quarter 2010 level by the end of
2013. Unemployment would peak at more than 11 percent by the first quarter
of 2012 and drop back to 9.5 percent by the end of 2013.
Federal Reserve spokeswoman Barbara Hagenbaugh declined to comment on the
specifics of the Fed’s parameters.
Growth Outlook
While Fed policy makers want banks to be prepared for a slump, they aren’t
predicting one. In January, members of the Federal Open Market Committee
forecast growth of 3.4 percent or more annually over the next three years,
with the jobless rate falling to 6.8 percent to 7.2 percent in the fourth
quarter of 2013. Unemployment averaged 9.6 percent in the final three months
of 2010.
As part of the most recent capital exam, regulators have made one of the
largest data requests in Fed history, outside of normal regulatory reporting
, asking banks for information about their securities, loans and other
holdings. This will give the Fed the ability to check and even challenge the
assumptions banks make about their portfolios.
Financial-Risk Unit
The tests are being overseen by a new financial-risk unit assembled by
Chairman Ben S. Bernanke and Tarullo. Known as the Large Institution
Supervision Coordinating Committee, or LISCC, the unit draws on the Fed’s
deep bench of economists, quantitative researchers, regulatory experts and
forecasters and looks at risks across the financial system. The LISCC last
year helped Bernanke respond to an emerging liquidity crisis faced by
European banks.
“The current review of firms’ capital plans is another step forward in our
approach to supervision of the largest banking organizations,” Tarullo
said. “It has also served as an occasion for discussion in the LISCC of the
overall state of the industry and key issues faced by banking organizations
.”
The Standard and Poor’s 500 Financials Index is up 7.5 percent this year,
compared with a 6.3 percent gain for the broader S&P 500 Index, as firms
such as BB&T Corp. in Winston- Salem, North Carolina, and U.S. Bancorp in
Minneapolis announced profit gains.
Dividend Plans
Bank of America Corp. Chief Executive Officer Brian T. Moynihan told
analysts last month that he expects to “modestly increase” dividends in
the second half of this year.
“We’d love to raise the dividend,” James Rohr, chief executive officer of
PNC, said in a Jan. 20 conference call. “We’re hopeful of hearing back in
March from the regulators.”
JPMorgan Chief Financial Officer Douglas Braunstein told investors Feb. 15
that the bank asked regulators on Jan. 7 for permission to raise the
dividend to 30 percent of normalized earnings over time.
Braunstein’s presentation showed that JPMorgan’s own stress scenario was
more severe than the Fed’s, with U.S. gross domestic product declining more
than 4 percent through the third quarter of this year. Unemployment peaks
at 11.7 percent.
Other banks that may raise dividends early this year include Bank of New
York Mellon Corp., San Francisco-based Wells Fargo & Co., U.S. Bancorp and
BB&T, according to research by Portales Partners in New York.
100 Fed Staff
The dividend increases, if they happen, will be one of the most carefully
screened payouts in U.S. regulatory history, with more than 100 Fed staff
working on the capital analysis of the banks.
Congress is also watching. The Fed should be cautious about allowing banks
to reduce their capital through dividends or stock repurchases, House
Democrats, including Representative Brad Miller of North Carolina, said in a
Feb. 15 letter to Bernanke.
“We applaud your undertaking new stress tests on the banks,” the lawmakers
said. “It appears doubtful, however, that the stress tests alone can
resolve the uncertainty facing those banks to justify reducing their capital
.”
The Fed’s involvement in decisions normally reserved for boards shows how
far the Dodd-Frank Act has pushed regulators into corporate governance.
“It is an uneasy balance between regulating an institution and running it,
” said Karen Shaw Petrou, managing partner at Federal Financial Analytics
in Washington, a research firm whose clients include the nations’ biggest
banks. The Fed is moving “far more assertively” on bank oversight, she
said.
2009 Stress Tests
As with the 2009 stress tests conducted by the Fed during the crisis, one of
the goals is to assure that bank capital can support new loans to
creditworthy borrowers. Loans and leases of banks in the U.S. contracted at
a 10.3 percent annual rate in 2009, a 6.2 percent rate in 2010, and at a 2.6
percent rate in January.
The Fed’s unprecedented exam of the 19 largest lenders in May 2009
concluded that 10 U.S. banks needed to raise an additional $74.6 billion in
capital.
Banks were “destroying” value when they repurchased billions of dollars of
stock in the years leading up to 2008, only to issue shares later at lower
prices after they needed capital amid the crisis, said Jefferies Group’s
Hatcher, a former bank examiner for the Federal Deposit Insurance Corp.
“Whether it is liquidity, capital or earnings, banks are on a much better
footing than they were a couple of years ago,” said R. Scott Siefers,
managing director at Sandler O’Neill & Partners LP in New York, a brokerage
and research firm specializing in financial companies. “Still, you can
pick your caveat. We are only in the early stages of an earnings recovery on
the lending side and the legislative and regulatory framework is still in
flux.”
To contact the reporters on this story: Craig Torres in Washington at
c******[email protected]; or Hugh Son in New York at 7872 or hson1@bloomberg.
net
To contact the editors responsible for this story: Christopher Wellisz at
c******[email protected]; Rick Green in New York at rgreen18 |
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