All of the banks stress tested by the Federal Reserve this year passed the now-annual ritual.
"The largest U.S.-based bank holding companies continue to build their capital levels and to strengthen their ability to lend to households and businesses during a period marked by severe recession and financial market volatility," the Fed reported on Thursday afternoon.
The purpose of the stress tests, which are mandated by the 2010 Dodd-Frank Act, is to ensure that banks won't be rendered insolvent in future financial cataclysms akin to the crisis of 2008-09. This is achieved by estimating how well the capital reserves of the nation's biggest banks would hold up under a series of hypothetical economic scenarios.
Under the "severely adverse" scenario in this year's test, it was assumed that unemployment would spike to 10%, home prices would fall by 25%, the stock market would drop by 60%, and market volatility would soar. Despite this, the Fed estimated that the cumulative tier 1 common capital ratio of the 31 firms examined would fall from 11.9% currently to a minimum level of 8.2%. At the nadir of the last crisis, by comparison, the figure bottomed out at 5.5%.
If you use the change in capital as a benchmark, then the worst-performing firms were Morgan Stanley, Zions Bancorporation, and Goldman Sachs, who were projected to see their tier 1 common capital ratios fall by 59%, 57%, and 56%, respectively. Meanwhile, among well-known traditional lenders, the three banks that held up best were US Bancorp, KeyCorp, and Huntington Bancshares, with analogous declines of between 10% and 13%.
Alternatively, if you look simply at estimated absolute losses, then the worst performing banks are, not surprisingly, also the largest. Over a hypothetical two-year time period, JPMorgan Chase was projected to lose $54.8 billion, followed by Citigroup at $48.4 billion, Bank of America at $37.3 billion, and Wells Fargo at $29.3 billion.
Either way, the important thing to note is that all 31 of the banks were expected to hold a sufficient amount of capital even at the trough of the hypothetical crisis to stay afloat and thereby avert a taxpayer bailout along the lines of the 2008 Troubled Asset Relief Program, or TARP.
"Higher capital levels at large banks increase the resiliency of our financial system," Federal Reserve Governor Daniel K. Tarullo said. "Our supervisory stress tests are designed to ensure that these banks have enough capital that they could continue to lend to American businesses and households even in a severe economic downturn."
The next step in the process is the comprehensive capital analysis and review, which the Fed uses to determine if banks can increase the amount of capital that they return to shareholders by way of dividends and share buybacks. Those results will be released later this month and will set the tone for the performance of bank stocks over the remainder of the year.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America, Apple, and Goldman Sachs. The Motley Fool owns shares of Bank of America, Apple, Citigroup Inc, Huntington Bancshares,, JPMorgan Chase, and KeyCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.