Fed Stress Tests 19 Banks: A Quick Road Test

The Fed's announcement of stress test results for 19 bank holding companies has provided balm for equity and debt holders, with the exception of four banks, which failed to maintain their core Tier 1 capital ratios at five percent of risk weighted assets at the end of the projection period, Q4 2013.  Although Met Life, Ally Financial, and Sun Trust failed the core Tier I test, the big news was that Citgroup also failed. 

There's no doubt that the economic scenario painted in the Fed's required simulation was extremely dire, and so the exercise is conservative in this respect.  Looking at the footnotes for Table 4 in the company projections, I suspect that the actual magnitudes for projected losses, revenue and net income could come in higher, lower and lower than projected, which would balance out the conservatism on the scenario choice.

Taking a quick look at a company like Keycorp which is included in the 19 company sample for the stress test, one still wonders how National City Bank was the only bank holding company in the Top 25 which failed to get Federal aid.  It got pushed into the arms of PNC for a song, further punishing shareholders.  It's still not clear to me how that happened, but enough on that aside.

Many of the ratios on the tables are rounded, so keep that in mind if some things don't add up.  Remember that the horizon we're looking at is 4Q 2011-4Q 2013. Beginning with Pre-Provision Net Revenue (PPNR), the format adds other revenue and subtracts Provisions, Realized Gains and Losses on Securities, Trading and Counterparty Losses, Other Losses and comes to Net Income Before Taxes.  A quick number that gives the flavor is to take the total swing PPNR to NIBT. In one sense, this is the total magnitude of the scenario's impact over the forecast period for a number that matters to investors.  For all 19 companies, this swing amount is $520.5 billion.  Here's the leader board for the swing from net revenue to loss:

1. Bank of America: $91.4 billion (17.6% of the sample total)
2. Citigroup: $91.4 billion (17.6% of the sample total)
3. JP Morgan Chase: $82.2 billion (15.8% of the sample total)
4. Wells Fargo: $72.9 billion (14.0% of the sample total)

These four bank holding companies, which are universally regarded as TBTF ("too big to fail") or Systemically Important, account for 65% of the total holding company sample's swing from PPNR to NIBT, which is negative in most cases, except for American Express, Bank of New York Mellon, and State Street which all would show positve NIBT in 4Q 2013. 

For the four leaders above, Bank of America, Citigroup and JP Morgan Chase all show significant Trading and Counterparty Losses during the simulation period: $21.1 billion, $20.9 billion, and $27.7 billion respectively.  It would be nice to understand how confident the Fed is in the computation of these losses.

If one goes back to a data set I like, the V-Lab from NYU's Stern School, it shows the top companies in "systemic risk %" being Bank of America, JP Morgan Chase, and Citigroup.  So, with different models and different simulations, we've identified the same characters, which is probably a good thing.  Let's focus the rest of the commentary on these Four Horsemen.

For the simulation period, the Total Loan Loss Table reads:

1. Bank of America--$70.1 billion
2. Citigroup--$67 billion
3. Wells Fargo--$58.3 billion
4. JP Morgan Chase--$55.8 billion

The Fed presentation shows loan losses by loan categories: First Lien Mortgages, Junior Mortgages and HELOC, C&I Loans, Commercial Real Estate Loans, Credit Cards, Other Consumer Loans, and Other Loans. 

Looking at Loan Losses as a Percent of Average Balances, Citigroup shows the highest aggregate percentage loan losses among the Four Horsemen above at 11.2%.  It shows the highest loss rates for First Lien, Junior and HELOC, and C&I Loans, the bread and butter of bank lending.

A reader can back into the average balances in each loan category, and in terms of dollars, Bank of America is the leader in aggregate loans with average balances of $845 billion, with $264 billion in first lien mortgages, $107 billion in junior mortgages and HELOC, and $160 billion in C&I loans. 

The largest card portfolio in terms of average balances is Citigroup at $146 billion, on which it is projected to generate $27 billion in losses under the simulation scenario.  JP Morgan Chase shows a credit card portfolio of $118 billion, which generates losses of $21 billion.  In the kind of severe economic and market downturn in the simulation, unsecured credit card lending bites back at bad underwriting and balance management. 

The group of four bifurcates into Wells and JPMC which passed their Tier 1 core capital tests and which have a a balance of businesses, the associated revenues and the ability to raise capital.  Bank of America, for all its good work in limiting liability for the mortgage debacle, still has challenges in the traditional product portfolio, and revenue growth will be a challenge; Merrill Lynch will probably be sold at some point, since its performance was relatively flat in 2011 compared to 2010, even though markets were heady.  Citigroup still seems like a directionless story, despite the successful financial engineering work to keep the ship from sinking. Revenue growth and value creation remain a mystery for the Citi That Never Sleeps.