Yahoo Finance Banks Clear 2024 Stress Test: Will Payouts be Bigger This Time?
Wall Street’s largest banks are ready to return excess capital to shareholders via dividends and share repurchases as all 31 cleared the Federal Reserve’s 2024 Stress Test. The outcome of this annual exercise shows how much capital banks need to be healthy and dictates how much they can return to shareholders.
The stress tests, mandated under the Dodd-Frank financial services law, were introduced in the aftermath of the 2008 financial crisis. It evaluates banks' capital adequacy, liquidity and risk management practices under adverse hypothetical scenarios, such as a deep recession and/or a sharp decline in asset prices.
Large banks, including JPMorgan JPM, Goldman Sachs GS, Wells Fargo, Morgan Stanley MS, Bank of America and Citigroup C, have been part of this process since the beginning. Further, banks with assets between $100 billion and $250 billion are tested every alternate year, effective 2019. This year, banks like Ally Financial, Citizens Financial Group and Fifth Third Bancorp FITB are also part of the annual exercise.
The balance sheets of all 31 banks were tested against an extremely hypothetical economic downturn, the elements of which change annually. This year's hypothetical scenario is broadly similar to 2023's scenario. It includes a severe global recession with a 40% decrease in commercial real estate (CRE) prices, a significant jump in office vacancies and a 36% plunge in house prices. Further, the unemployment rate rises nearly 6.5% to a peak of 10%, and economic output declines commensurately.
Per the Federal Reserve, under this year’s hypothetical severe downturn, the 31 lenders that have more than $100 billion in assets are likely to suffer a combined loss of $685 billion. This includes $175 billion from credit cards, $142 billion from business loans and almost $80 billion from commercial real estate.
Vice Chair for Supervision Michael S. Barr said, “While the severity of this year's stress test is similar to last year's, the test resulted in higher losses because bank balance sheets are somewhat riskier and expenses are higher.”
The central bank also noted that under stress, the aggregate CET1 capital ratio is anticipated to fall 280 basis points from 12.7% to 9.9%. It is well above the required minimum of 4.5%. The capital ratios help measure how strong a cushion a bank holds against unexpected losses, and banks that perform well typically stay well above the minimum level.
Thus, banks like JPMorgan, Goldman, Wells Fargo, Morgan Stanley, Bank of America, Citigroup, Ally Financial, Citizens Financial Group and Fifth Third Bancorp can use their excess capital to issue dividends and buy back shares.
However, this time, most lenders are expected to be modest in rewarding shareholders until there is clarity on new capital requirements. Further, lingering headwinds like higher interest rates for a longer time frame and ambiguity over the CRE loan portfolio because of an expected economic slowdown are likely to hold back banks.
But to know exactly what these 31 banks plan to do with excess capital, one will have to wait till at least late Friday.
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