Big banks make it through stress tests, investors await cash release

Key Points
  • The 34 banks subjected to the Fed's stress testing appear to have enough capital to return cash to shareholders.
  • The second, more critical part of the test happens next week when the central bank announces whether it approves or disapproves of the banks' capital plans.
  • The tests are part of the Dodd-Frank regulatory reforms instituted after the financial crisis.
Goldman Sachs: We're seeing the evolution of stress testing
Goldman Sachs: We're seeing the evolution of stress testing

U.S. banks made it through the latest round of stress testing relatively unscathed, setting investors up for news next week of payouts from the industry's biggest names.

Test results released Thursday by the Federal Reserve show that the 34 institutions under scrutiny have enough capital to make it through the two scenarios regulators posed — one akin to the financial crisis and another entailing a shallower downturn.

Under the scenarios, the banks tested "would experience substantial losses." However, in total, the institutions "could continue lending to businesses and households, thanks to the capital built up by the sector following the financial crisis."

The tests marked the third straight year the banks all met the Fed's standards for health and could boost arguments from Republican legislators and President Donald Trump for loosening regulations.

"This year's results show that, even during a severe recession, our large banks would remain well-capitalized," Fed Governor Jerome H. Powell said in a statement. "This would allow them to lend throughout the economic cycle, and support households and businesses when times are tough."

In the most severe scenario, bank losses are projected to be $493 billion. In the less severe, the losses were put at $322 billion.

The tests are part of the Dodd-Frank reforms instituted after the crisis that mandated banks raise capital levels to brace against another crisis.

Thursday's results are the first in a two-step process, with the second and more important happening Wednesday when the Fed will approve or disapprove the banks' plans to return capital to shareholders. Indications are that some of the largest banks want to return more than 100 percent of profits.

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That would indicate a major change in confidence on the part of both banks and regulators as the institutions would begin actually reducing capital positions.

"Today's results reaffirm that U.S. banks are strong and remain well-positioned to continue playing their important role in accelerating economic growth," Rob Nichols, president of the American Bankers Association, said in a statement. "Banks' robust capital and liquidity positions would allow them to continue to function well under even the most extreme scenarios."

Fed officials emphasized that the stress tests don't come with pass or fail grades though the results bode well for banks passing the second part of the test next week. The second round, however, uses different criteria, so that solid results from Thursday do not automatically signal that all the plans will be approved.

But in terms of whether the banks have enough top-quality assets compared to liabilities, Thursday's results indicated that the institutions were on safe ground. That measure, called the tier-one capital ratio, was exceeded by all 34 banks. As a whole, the industry would see its current tier-one ratio fall from 12.5 percent to 9.2 percent. For individual banks, the Fed requires a level of 4.5 percent.

Under the most severe scenario, which also entails heightened stress in corporate loan markets and a 35 percent decline in commercial real estate prices, banks are projected to lose $493 billion over a period of nine quarters.

In addition, the eight largest firms would see $86 billion in trading losses, with JPMorgan Chase, the biggest bank by assets, suffering the biggest losses at $25 billion.

The results come at a time when Washington lawmakers are looking at rolling back some of the Dodd-Frank measures. A Republican-sponsored measure would reduce the authority that regulators have and raise the level of assets for which banks would undergo the type of scrutiny that the stress tests employ. The Fed uses $50 billion as the current yardstick, but some legislators would like to raise the level to about $250 billion.

Bank stocks traded broadly lower Thursday and have been sideways since getting a big boost after Trump's November election victory.

— With reporting by CNBC's Dawn Giel.

Watch: Large banks remain well-capitalized

Large banks would remain well capitalized under stress: Fed Governor Powell
Large banks would remain well capitalized under stress: Fed Governor Powell