OREANDA-NEWS. March 10, 2015. Yesterday's release of the Dodd-Frank Act Stress Test (DFAST) results showed all 31 U.S. bank holding companies passing minimum capital ratio requirements, demonstrating very modest improvements in projected loan losses and mostly wider margins of cushion above capital minimums, according to Fitch Ratings. DFAST is the first part of annual stress testing for the largest U.S. banks and is followed by results of the Comprehensive Capital Adequacy Review (CCAR), which overlays the banks' planned capital actions. The CCAR is to be released on March 11.

The Fed's weighted average minimum stressed Tier 1 common (T1C) capital ratio was 8.2% under the severely adverse scenario, up from 7.6% in last year's test. Banks also had a higher starting point for the ratio, averaging 11.9%, compared with 11.5% a year ago. Under the FED's adverse scenario, a more interest rate sensitive case, the average T1C minimum would drop to just 10.8%. This year's results included the added challenges of higher risk-weighted assets from projected asset and lending growth, the impact of increased equity volatility on market risk RWAs, as well as higher credit-related RWAs for some banks due to the phase-in of Basel III.

DFAST assumes each bank holds its existing dividends constant, whereas the CCAR overlays planned increases to dividends, share repurchase activity, and capital issuances or redemptions. While the large majority of banks fare well quantitatively under DFAST, the threat of a capital plan rejection under CCAR for qualitative reasons is a more significant hurdle for the banks. Such qualitative failures occurred last year for four institutions, even though each had exceeded all required quantitative thresholds. As regulators increase their risk management expectations regarding stress testing, the banking industry has significantly increased spending and resources dedicated to the processes.

Largest US Banks Account for Over Half of Projected Losses

The five largest global trading and universal banks -- JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley -- saw significant declines on average, dropping about 6.1 percentage points from their starting T1C ratios under the severely adverse scenario. These five banks accounted for about 58% of the \\$490 billion in total projected losses under the severely adverse case.

Citigroup, Goldman Sachs, JPM, and Morgan Stanley exceeded all capital ratios minimums, though without a significant amount of cushion. For example, Goldman Sachs' minimum total risk-based capital ratio was a projected 8.1%, as compared to an 8% minimum.

These banks, along with Wells Fargo, also faced both a global market shock and a major counterparty default. Trust and processing banks State Street and Bank of New York Mellon faced only the major counterparty default. Combined, these effects resulted in \\$103 billion of trading and counterparty losses under the severely adverse scenario, similar to the \\$98 billion of trading and counterparty losses in the 2014 exercise. The 2015 level reflects reduced risk on balance sheets, but somewhat more volatile and severe equity asset price declines in the 2015 scenario.

Fitch believes that these eight banks ultimately subject to the Fed's G-SIB capital surcharges may begin to temper dividend increases in favor of share repurchases over time, though the rules are still not finalized.

Regional, Foreign Owned Banks Less Affected By Stress Test

Most large regional banks again were less affected by the stress test. Of the 14 large regional banks, the projected decline in capital ratios was the lowest for US Bancorp, Huntington Bancshares, KeyCorp, Sun Trust, PNC, Comerica, and Fifth Third. Wells Fargo's stressed T1C ratio was 7.5%, a drop of 3.3 percentage points from its starting point, versus a 2.4 percentage point drop last year.

Not all regionals performed well. Zions Bancorporation came very close to the 5% T1C capital ratio minimum, ending up with a projected ratio of 5.1%. Last year, Zions was the only bank to not exceed all capital ratio thresholds during DFAST with a minimum T1C ratio of 3.6%.

The six foreign-owned banks taking this year's DFAST fared mostly well, with five of the six banks maintaining minimum T1C ratios above 8.0% in the severely adverse scenario. While all of the foreign owned banks also passed during DFAST last year, three of the five banks went on to receive objections to their capital plans due to qualitative reasons during the second round. Deutsche Bank Trust Corporation is the only new participant in this year's stress test. Its extremely high quantitative DFAST capital outcome (34.7%) is illustrative of the immaterial size of the operation relative to the whole Deutsche Bank group rather than providing any indication of how capital at Deutsche Bank is managed globally.

Equity Decline, Market Volatility More Severe in 2015 Scenarios

DFAST's 2015 severely adverse scenario assumes that U.S. corporate credit quality deteriorates sharply with spreads on high-yield bonds, leveraged loans, and CLOs widening to levels seen during the financial crisis over the nine-quarter evaluation period. The scenario included five quarters of negative GDP, dipping as low as negative 6.1% (same as last year), an unemployment spike to 10.1% (versus 11.3% last year), and peak-to-trough declines in equity and housing price valuations of 58% and 25%, respectively. Equity declines were more severe in 2015 versus 2014's test, as were peak market volatility index (VIX) levels. Home price depreciation is meant to be particularly relevant for those states or cities that have experienced more appreciation over the past couple years.

Under the 2015 adverse scenario, the flat yield curve (versus a steep yield curve in 2014), higher peak inflation (4% versus 2%), and the steepness of the decline in equity valuations made the scenario's stress more challenging than last year. This impacted regulatory capital ratios for the Advanced Approach banks with close to \\$100 billion being deducted from fourth quarter 2016 capital ratios, a third of which was at Citigroup. The interest rate scenario under the adverse scenario, which includes short-term rates spiking to 5.3%, with less movement on the long end, is also intended to expose risks to the banks' funding costs, with customers migrating to higher-yielding alternatives or leaving the system altogether.