Banking

The Fed examined how local banks would fare in another downturn. Here's what it found.

The Federal Reserve Board building in Washington, D.C. On Thursday, the Fed released results of the second round of its annual "stress tests" on large banks.
The Federal Reserve Board building in Washington, D.C. On Thursday, the Fed released results of the second round of its annual "stress tests" on large banks. AP

Bank of America, Wells Fargo and 33 other large financial firms could weather the next financial crisis, according to the latest "stress test" results released Thursday by the Federal Reserve.

In the annual tests, required under 2010's Dodd-Frank financial overhaul law, the Fed analyzes whether large bank holding companies have enough capital to absorb losses and continue lending in an economic downturn. This year's tests involved 35 U.S. and foreign firms representing about 80 percent of the assets of all banks operating in the U.S., the Fed said.

The exams are designed to help the Fed avoid a repeat of the 2008 financial crisis by testing the resiliency of the banking system. They're also meant to foster public confidence that banks can weather another economic downturn, after taxpayers bailed out the firms in the last crisis.

Capital is important to ensuring that losses are borne by shareholders, the Fed said.

Senior Fed officials speaking to reporters on a conference call Thursday said the results show the firms continue to be strongly capitalized. They also noted that this year's tests are the most stringent, a function of the U.S. economy being the strongest since the tests began.

But one key measure of capital cushions fell to a lower minimum across the firms, which Fed officials attributed partly to the tax law. The legislation, passed in December, lowered the rate corporations pay on profits from 35 percent to 21 percent.

The measure, which compares high-quality capital to firms' risk-weighted assets, fell to a post-stressed minimum average of 7.9 percent, below last year's minimum of 9.2 percent. Fed officials said a factor in the decline is the reduction or elimination of some benefits companies had before before the tax changes, such as the ability to carry forward or backward certain losses.

The officials emphasized that 7.9 percent was still a "solid" post-stress capital level. The Fed requirement is 4.5 percent.

In its analysis, the Fed runs banks through hypothetical downturn scenarios whose conditions it resets every year.

This year, the most extreme scenario included a severe global recession in which U.S. unemployment rises almost 6 percentage points to 10 percent by the third quarter of 2019. Bank of America, Citigroup, Wells Fargo and three other banks with large trading activities were also subjected to hypothetical shocks to global markets.

In the harshest downturn, Charlotte-based Bank of America would suffer $49.7 billion in loan losses, according to Fed projections. Wells Fargo, which is based in San Francisco, would have $53.6 billion in losses. BB&T, based in Winston-Salem, would see losses of $8.4 billion.

Combined, the three banks are the largest by deposits in the Charlotte market.

"Despite a tough scenario and other factors that affected this year's test, the capital levels of the firms after the hypothetical severe global recession are higher than the actual capital levels of large banks in the years leading up to the most recent recession," Fed Vice Chairman Randal Quarles said in a statement.

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Thursday's tests are the first in a two-part testing process.

There's no pass or fail for banks Thursday, and banks don't face any consequences from the Fed no matter how far their capital levels drop under the hypothetical downturns.

Performance on next week's second round of testing, though, has big implications for investors. In those tests the Fed can block banks' plans for returning more capital to shareholders — such as through buying back stock or boosting dividends — if capital levels don't meet regulator minimums. Banks can also be dinged for "qualitative" issues, such as weaknesses in determining the appropriate amount of capital for their risks.

Round-two results will be released next Thursday. In the past, those disclosures have been followed on the same day by a spurt of announcements by banks about plans for raising dividends or buying back stock.

Typically, a majority of banks pass the tests, but some have hit snags.

Bank of America, which cleared last year's exams, is among firms that have stumbled multiple times.

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