The largest U.S. banks -- which also control a large chunk of the U.S. mortgage market -- are bracing for the release of stress test results this week by the Federal Reserve Board. And the stakes have seldom been higher.
The test, which bank executives describe as a "very taxing" exercise given the reams of financial documents and calculations they provide to the Fed, will determine what firms can pay a dividend to shareholders, and it will likely shape public perceptions of the health of the institution.
"If a bank fails the test, or does not get approval for what it hoped to get, the negative could be the market reaction to that specific bank," said Joseph Pucella, senior bank analyst for Moody's Investors Service. "From a credit perspective, if a bank does not meet the Fed's capital requirements under the stress test, then it's a good thing that the bank will be restricted from increasing its dividend. At the same time, the market could have a negative reaction if the bank is singled out as a weaker player."
Without much public notice, the Fed met in a closed meeting Thursday to discuss the stress test results. It is expected to release the data by March 15.
Banks have had to undergo stress tests before, but this round marks the first time since the financial crisis that the results will be made public — and it is arguably the most severe version of the test, given the harsh variables that banks had to score themselves against.
"This time around the scenarios were much harsher," said Sabeth Siddique, a director at Deloitte & Touche LLP and a former assistant director of banking supervision and regulation at the Fed. "And that's in part due to the continued uncertainty in the economic environment as well as some of the potential spillover effects from Europe."
Those variables included projecting a bank's condition if unemployment jumped to 13% (it is currently at 8.3%), the Dow Jones Total Market Index fell to 5,700 points and a sharp decline of gross domestic product to minus-8%.
While those variables must be tested by the 19 largest banks, the six biggest must go even further.
Companies like Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. have to run a global market shock scenario that replicates similar events that occurred during the second half of 2008.
