The results of the Federal Reserve's annual stress test (DFAST) on the U.S. banking system were released late yesterday afternoon simultaneously with the annual CCAR. The stress scenario applied for the exercise was consistent with current economic conditions assuming a "V" shaped recovery in the current year. All participating institutions performed well within that context, with capital builds over previous years allowing for the system to broadly absorb emerging losses and remain "well capitalized".
Unlike other years, however, the Fed overlaid the current stress test with a sensitivity analysis that incorporated the COVID-19 pandemic impact on economic conditions that would drive both "U" and "W" shaped recoveries. Under the latter scenarios, 25% of participating institutions would have Common Equity Tier I ratios of 5.5% or less ("U" shaped), or 4.8% or less ("W" shaped) against a 4.5% minimum level.
To ensure the system's resiliency in the event of a more prolonged ("U") or volatile ("W") downturn, the Fed announced the following:
Within our coverage universe, Wells Fargo and Capital One appeared to be the only banks that could potentially lower dividends in Q3 under the current conditions. Citizens, Huntington and KeyCorp are the most likely to see dividend cuts under the more adverse scenarios (Barclays Equity Research). In any event, the results are constructive from a credit standpoint, as capital distributions and capital positions will be scrutinized on a rolling basis rather than annually.
Editor's Note: The title of this blog post is a reference to the opening lyric of the 1988 hit "Fast Car" by Tracy Chapman
Barclays Equity Research, Stress Test 2020, June 26, 2020
Board of Governors of the Federal Reserve System, Assessment of Bank Capital during the Recent Coronavirus Event, June 2020
Board of Governors of the Federal Reserve System, Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Results, June 2020