Bank Stress Test Results Good Not Great

The U.S. Federal Reserve released the 2018 results from the supervisory stress tests conducted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The tests serve to inform regulators, financial markets, and the general public how institutions' capital would withstand a hypothetical set of adverse economic conditions. All 35 of the banks subject to the stress test performed adequately on the most commonly watched measure, the common equity Tier 1 capital ratio, although we note that results were on average worse than last year. State Street, Goldman Sachs, and Capital One all had their stressed common equity Tier 1 ratios fall below 6%, whereas the lowest performer last year went only to 6.5%. Even so, all were still above the 4.5% regulatory minimum. All six of the new foreign banks, which were added to testing this year, passed the regulatory minimums as well, although the real test for them will be the qualitative testing of Comprehensive Capital Analysis and Review, or CCAR. These results are satisfactory, and it is not surprising that all have passed, given that banks have been adding common equity capital--over $800 billion since 2009--to strengthen their balance sheets. However, given the tougher hits to banks' common equity Tier 1 ratios, it may prevent a bonanza of capital returns to shareholders this year, although we should note that many banks were already paying out over 30% of earnings in dividends, and close to or over 100% when factoring in share buybacks. Therefore we expect stability for capital returns overall, with the most room for increases within the 18 banks that had stressed results that were no worse than 1-percentage point of last year's stressed common equity Tier 1 results. We expect potentially some more conservatism for those hit hardest this year. We are currently maintaining our fair value estimates and economic moat ratings for the banks.

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