Fed Says 17 of 18 Top US Banks Have Strengthened

All but one of the nation’s 18 largest banks are more prepared to withstand a severe U.S. recession and a global downturn than at any time since the 2008 financial crisis, the Federal Reserve says.

Results of the Fed’s annual “stress tests” showed Thursday that as a group, the 18 banks hold fewer bad loans compared with last year, helped by a stronger economy. The Fed will announce next week whether it will approve the banks’ plans to issue dividends or repurchase shares.

The Fed’s data show that one of the banks, Ally Financial Inc., would have a much lower capital buffer against losses than the others under the most severe scenario. Ally’s projected capital level is below the minimum that the Fed considers a bank would need to survive a severe recession.

But Fed officials wouldn’t say whether that means it would reject Ally’s plans for issuing dividends or buying back shares.

Last year, Ally – the former financial arm of General Motors – was the worst-performing bank in the Fed’s stress tests. It was one of four banks that failed the tests and were not allowed to raise their dividends or repurchase shares. The others were Citigroup Inc., SunTrust Banks Inc. and MetLife Inc., which has since sold its banking operations and is no longer tested.

In a statement, Ally countered that it was well-capitalized, and called the Fed’s analysis for calculating the bank’s potential losses “fundamentally flawed.”

“While Ally appreciates the Fed’s role in ensuring that financial institutions have adequate capital during stressed situations, using flawed assumptions could have lasting adverse impacts on the economy, including ultimately causing banks to reduce certain key lending categories,” the bank said.

The 18 banks were tested on how they would withstand severe downturns not only in the United States but also in Europe and in Asian countries including China and Japan.

Under the stress tests’ most severe scenario, the United States would undergo a recession in which unemployment would reach nearly 12 percent, stocks would lose half their value and home prices would plunge 20 percent.

The Fed said that under the most severe scenario, the 18 banks would suffer combined losses of $462 billion through the fourth quarter of 2014.

In the aftermath of the financial crisis, the Fed has conducted stress tests of the largest banks every year since 2009.

Next Thursday, the Fed will announce whether it has approved each bank’s request, if it made one, to raise dividends for its shareholders. Its decisions will be based on how each bank would fare in a severe recession if it increased its dividends.

“The stress tests are a tool to gauge the resiliency of the financial sector,” Daniel Tarullo, a Fed governor, said in a statement.

Tarullo said significant increases in the amount and quality of banks’ capital cushions against risk “help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.”

The 18 banks, along with hundreds of other U.S. banks, received federal bailouts during the financial crisis that struck in 2008 and triggered the worst economic downturn since the Great Depression of the 1930’s. The banking industry has been recovering steadily since then, as overall profits have risen and banks have started to lend more freely.

Stress tests are annual checkups the government gives the biggest banks. The banks’ balance sheets are tested to see how they’d survive a severe recession. The tests are a gauge of how the industry is faring more than four years after the crisis hit.

Many longtime bank shareholders are unhappy with their investments, because most banks’ stock prices still have yet to return to pre-crisis levels. But raising dividends costs a bank cash. The government doesn’t want banks to deplete their capital reserves so much that they’d become vulnerable to another recession.

Citigroup and Bank of America Corp. are each still paying shareholders only a token dividend of one penny, because the government hasn’t allowed them to raise it.

Some experts say they aren’t sure that even a thumbs-up from the stress tests carries much significance. The industry is no longer in dire shape, but it’s still under pressure. Uncertain legal fees and new regulations are restraining profits and revenue, and demand for loans has been generally lackluster.

Chris Whalen, a New York-based analyst, argued that the Fed appears too eager for banks to return capital to shareholders. He said the industry still faces problems.

“Weak profitability and slow revenue growth should be the key areas of concern in the (stress test) analysis, but there will be no discussion of these factors,” Whalen wrote in a post shortly before the results were released.