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Would Wells Fargo Stay Above the CET1 Minimum in Stress Test Scenario?

By Dave Kovaleski – Jun 26, 2020 at 12:14PM

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Yes, it would: The giant bank revealed Thursday that it had passed its recently conducted stress test.

Based on the results of its annual stress test, Wells Fargo (WFC -0.69%) would remain well above the Common Equity Tier 1 (CET1)  ratio even in the event of a severe and lengthy global recession, the bank said Thursday.

The stress tests, which banks conduct under the watchful eye of the Federal Reserve in accordance with the Dodd-Frank Act, are designed to assess the institutions' ability to weather highly adverse conditions. This year, the Fed had banks determine how they would fare under a hypothetical nine-quarter scenario -- covering a period from Jan. 1, 2020 to March 31, 2022 -- that featured a severe global recession with real gross domestic product (GDP) falling 8.5% over the first seven quarters and unemployment rising to 10% in the third quarter of 2021. Under this scenario, the interest rates on short-term Treasuries would remain near zero throughout.

The word bank written across a building facade with buildings in the background

Image source: Getty Images.

If this situation were to occur, Wells Fargo would suffer a total net loss before taxes of $23.1 billion. This reflects projected losses of $49.9 billion from provisioning for credit losses, trading and counterparty credit losses, and losses on debt securities, which would be partially offset by net revenue of $26.9 billion.

The bank's Common Equity Tier 1 ratio -- the institution's core capital divided by its risk-weighted assets -- would decrease from 11.1% on Dec. 31, 2019, to 9.6% on March 31, 2022. Its lowest projected CET1 ratio was 8.8%, which would still be well above the 4.5% regulatory minimum. The CET1 is an important gauge of a bank's ability to sustain losses while maintaining normal operation.

Further, Wells Fargo pointed out that the stress test results included the assumption that it would maintain its dividend payments throughout the extended recession. "In practice, if this scenario were to occur, the company would take capital conservation actions mandated by internal policy, which would include but not be limited to both changes in common stock dividend payments and share repurchases."

Wells Fargo's share price was down by about 6.5% at noon EDT on Friday. The stock is down 52% year to date.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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