The Federal Reserve recently released new bank capital requirements for large banks, which tells them how much regulatory capital they need to hold to absorb future expected and unexpected loan losses. The release comes about a month after the Fed conducted its annual stress testing, in which it puts the largest banks through adverse and hypothetical economic conditions to see how their balance sheets would hold up. This year, due to the coronavirus pandemic -- and the particularly difficult economic conditions that came with it -- the Fed ran additional scenarios to see how banks would perform in certain economic scenarios that could be caused by the pandemic. Stress testing is important because it determines how much capital banks will have to hold for at least the next year, starting in October.
While it is very important that banks are well capitalized and have enough capital to absorb significant losses, the more capital banks have to hold, the less they can deploy into interest-earning assets such as securities and loans. That may not be important right now, but if economic conditions normalize in a few months, it will be much more relevant. These ratios also play a role in determining a bank's capital distributions because if banks' capital ratios fall below their required minimum threshold, they may have to scale back their dividend or stock buyback plans. The Fed released new requirements for banks' common equity tier 1 (CET1) capital ratio, which is a measure of a bank's core capital such as retained earnings, common stock surpluses, and accumulated other comprehensive income expressed as a percentage of risk-weighted assets. Here are seven U.S. banks that saw their CET1 ratio requirements increase.
Image source: JPMorgan Chase.
1. Goldman Sachs
Goldman Sachs (GS 0.22%) will see its current CET1 ratio requirement jump from 9.5% to 13.7%. The Fed's stress testing results saw Goldman's CET1 ratio in a severely adverse scenario fall to a low 6.9%, which was toward the bottom end of the group. It was also problematic for Goldman at the time because like most banks, Goldman's CET1 ratio fell significantly after the first quarter of the year -- to 12.5%. But the bank built capital back up and raised its CET1 ratio to 13.6% after the second quarter, giving it plenty of time to get into compliance with its new threshold by October. "We have a track record of rebuilding capital when necessary," Goldman's CEO David Solomon said in a press release back in June.
2. JPMorgan Chase
JPMorgan Chase (JPM 2.51%) is another bank that will see its requirement go up, from 10.5% to 11.3% starting in October. The bank's current CET1 ratio settled to 12.4% at the end of the second quarter, up from 11.5% in the first quarter. While the bank has some room to work with right now, if economic conditions deteriorate worse than the bank expects, and JPMorgan has to build reserves again or sees significant drawdowns on existing lines of credit -- if, say, another period of significant shelter-in-place orders occurs -- it could see its CET1 ratio drop down close to that new threshold. I'm sure the bank is not happy to see the increase, especially after managing to turn a decent profit through the first six months of the year, while setting aside close to $19 billion to cover potential loan losses. Also, none of JPMorgan's most direct competitors such as Bank of America, Citigroup, or Wells Fargo, saw their required CET1 ratios increase.
3. Citizens Financial Group
The $180 billion-asset Citizens Financial Group (CFG 3.31%) will also feel the sting of a required increase, seeing its CET1 ratio requirement go from 7% to 7.9%. Most large regional banks like Citizens will get to keep their required CET1 ratios at 7%. Citizens' CET1 ratio ended the second quarter at 9.6%. The bank clearly did not like the call, as it has asked the Fed to reconsider its stress capital buffer, one layer of the CET1 ratio that resulted in the overall increase to Citizens' CET1 ratio. "The Company believes the Federal Reserve's credit loss modeling methodology does not fully reflect the consideration of certain loan characteristics and certain counterparty loss-sharing obligations, resulting in higher credit loss rate estimates," Citizens CEO Bruce Van Saun said in a press release following the Fed's stress testing results.
4. Capital One
Credit card company Capital One (COF 0.90%) will see its required minimum CET1 ratio go from 7% to 10.1% in October, another big jump. The company, which plans to trim its dividend by 75% in the third quarter, had a CET1 ratio of 12.4% at the end of the second quarter, which leaves some room, but also makes for a much tighter window than before. Although credit card portfolios can experience much more significant losses than other loan categories during recessions, Capital One fared much worse than peers American Express and Discover (DFS 0.87%) in the Fed's stress testing results, with its CET1 ratio falling to 6.8% in the Fed's severely adverse scenario.
5. Regions Financial
The $144 billion-asset Regions Financial (RF -0.53%) will see its CET1 requirement go from 7% to 7.5%. Regions finished the second quarter with a CET1 ratio of 8.9%. Similar to Citizens, this is disappointing for a large regional bank because many of its peers only have a 7% CET1 ratio requirement.
6. Morgan Stanley
Like Goldman Sachs, investment bank Morgan Stanley (MS 0.44%) also will see its CET1 ratio requirement rise significantly, from 8.6% to 13.4%. But it's not as big of an issue for Morgan Stanley, which had a 16.1% actual CET1 ratio at the end of the second quarter.
7. Discover
Credit card company Discover saw its CET1 ratio requirement go from 7% to 8%. But with a CET1 ratio of 11.7% at the end of the second quarter, the company is still in good shape.
