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The Fed's Stress Test Results Open The Door For U.S. Banks To Increase Capital Returns In 2021


S&P Stress Test Suggests Large Brazilian Banks Could Withstand Second Virus Wave


Good Earning Capacity Gives Rated Banks In Emerging Markets A Buffer From COVID-19's Effects


Industry Report Card: Large U.S. Banks' Earnings Should Improve In 2021 While Profitability Will Lag Pre-Pandemic Levels


Europe's Distressed Debt Purchasers Look To Steady The Ship In 2021

The Fed's Stress Test Results Open The Door For U.S. Banks To Increase Capital Returns In 2021

In an effort to gauge how U.S. banks would perform in the worsening economic conditions due to COVID-19, the Federal Reserve conducted a second stress test in 2020. Typically, it does only one per year, but the first stress test scenarios had been articulated prior to COVID-19. The recently released results showed that the 33 banks that participated in the test are well-positioned to maintain capital levels above the minimum under two hypothetical scenarios.

In particular, the Fed updated its severely adverse scenario and provided an alternative severe scenario (see appendix for details). The results showed that in aggregate, for the 33 banks, their common equity Tier 1 (CET1) ratio declined from its starting point of 12.2% in June 2020 (20 basis points higher than where it was in December 2019) to a minimum of 9.6% under the severely adverse and 9.7% under the alternative severe scenario, well above the regulatory minimum of 4.5% (see table 1).

The results of December's test were more benign compared with the more dire possibilities presented in June's additional scenarios. As a result, the Fed is now allowing the banks that participated in the test to repurchase a limited amount of shares in the first quarter, based on the level of their recent income.

Despite greater projected loan losses, the results of the December test were not far worse than those in the severely adverse scenario of the June test. The June test showed a 2.1% CET1 ratio reduction to a minimum 9.9%, compared with December's 2.6% decline and 9.6% minimum in the severely adverse scenario. (For the results of the test in June, see "The Fed’s Latest Stress Test Points To Limited Bank Capital Returns," June 30, 2020.)

One of the reasons for that is capital ratio starting points were higher because of capital build in the first half of the year due to restricted shareholder payouts. Also, banks have built significant allowances, helping to cushion the Fed's larger assumed losses (greater than $600 billion in December's test versus $550 billion in June). As a result, projected provisions were lower in the December test than the June test. That said, the allowance build is partially offset by lower pre-provision net revenue assumptions in December's test (roughly $370 billion versus $430 billion in June).

Table 1

Aggregate Capital Ratios Under Stress Scenarios (%)
--Stressed minimum capital ratios--
Regulatory ratio Actual 2Q2020 Severely adverse Alternative severe Minimum regulatory capital ratios
Common equity tier 1 capital ratio 12.2 9.6 9.7 4.5
Tier 1 capital ratio 13.8 11.3 11.4 6.0
Total capital ratio 16.4 14.0 14.1 8.0
Tier 1 leverage ratio 7.9 6.4 6.4 4.0
Supplementary leverage ratio 7.4 5.2 5.2 3.0
Note: The supplementary leverage ratio is calculated only for firms subject to Category I, II, or III standards. Source: Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Result.

Less Severe Stress Than In June's W-Shaped And U-Shaped Scenarios

The results of December's stress test are in sharp contrast to pandemic-related overlay analyses the Fed conducted in June, in addition to its traditional severely adverse scenario. At that time, the Fed projected very sharp declines in capital in special U- and W-shaped economic recovery scenarios meant to take into account the possible impact of COVID-19. It projected aggregate minimum CET1 ratios of 8.1% and 7.7% in those scenarios, respectively, with some banks almost reaching their minimum capital requirement of 4.5%. Notably, the aggregate minimum CET1 ratio of 9.7% in December's alternative severe scenario is well above those levels.

We believe that's because banks and the economy have performed better than may have been feared early in the pandemic, and the type of stress incorporated in the U- and W-shaped scenarios now looks less likely. For instance, the W-shape had assumed a 12.4% peak-to-trough GDP decline and a loan loss rate of 9.9%. By comparison, December's severely adverse scenario has a 3.25% GDP decline and a loan loss rate of 7.7%, and the alternative severe scenario has an annualized GDP decline of 9% in fourth-quarter 2020 and growth of 2% in 2021.

By the end of the first quarter, the Fed will revisit its updated payout restrictions. Separately, as a result of banks' plan submissions, the Fed may elect to recalculate a bank's stress capital buffer (SCB)--the burndown, or decline, in a bank's capital ratios under the Fed's severely adverse stress scenario to minimum levels. The Fed has extended the deadline by which it can notify banks whether their SCB requirements will be recalculated to March 31, 2021. We calculate that 10 of 22 U.S.-domiciled banks' capital burndown in the December test was more than 50 basis points (bps) higher than in the June test. M&T showed the most significant change of a roughly 450 bps decline in capital, versus a 120 bps burndown in June (table 3). Alternatively, seven of the U.S.-domiciled banks' burndown was less in December than in June.

Our ratings reflect the resiliency of the U.S.-domiciled banks that participated in the December stress test. Of the 22 U.S.-domiciled banks that were included in the stress tests, about 80% have stable outlooks. Our negative outlooks on Ally Financial, Capital One, Discover Financial Services, Huntington Bancshares, and M&T Bank Corp. largely reflect either these banks' concentration in loan sectors we believe are potentially most vulnerable to COVID-19 (largely auto, credit cards, and commercial real estate), or merger-related activities.

In the aftermath of December's stress test results, we have lowered our loss rate assumption for our rated banks to 2.2% from our previous assumption of 3% over the next two years. This revision to our U.S. banking sector loss forecast is based on a combination of recent positive developments, including:

  • Vaccine development and distribution in 2021;
  • Greater stabilization in the economic outlook on the heels of the passage of additional fiscal stimulus;
  • A third-quarter pause in bank allowance build; and
  • Recent anecdotes from bank management teams suggesting a more sanguine outlook for credit losses in the quarters to come.

Capital Return Analysis

In the December stress test results, the Fed left in place its restriction on dividend increases but eased its prohibition of share repurchases starting in the first quarter of 2021. Specifically, the Fed will allow shareholder payouts (the sum of dividends and share repurchases) in the first quarter up to an amount equal to each bank's average quarterly net income in 2020. Based on this formula, we estimate that all of the U.S.-domiciled banks can opt to commence repurchasing shares in the first quarter but to varying degrees (see table 2). Notably, since the stress test results were announced, several banks have already declared their intention to repurchase shares in the first quarter. Still, total payout ratios (dividends and possible share repurchases in the first quarter) for many banks would constitute less than 100% of a run rate of projected fourth quarter-earnings.

The ability to repurchase shares aligns with our expectations even prior to the release of the stress test results, and explains why we had assumed capital ratios would decline in 2021.

In addition, the Fed is allowing all banks that participated in the test to make share repurchases that equal the amount of share issuances related to employee compensation. It's also allowing banks to redeem and make scheduled payments on additional Tier 1 and Tier 2 capital instruments.

Table 2

Common Dividend Payout Ratio And Permissible Share Repurchases
Bank holding company Estimated quarterly average 2020 net income (mil. $) Common dividend payout ratio/NI (%) Permissible Q1 2021 share repurchase/NI (%) Permissible Q1 2021 share repurchase (mil. $)

Huntington Bancshares Inc.

200 78 22 44

Regions Financial Corp.

219 68 32 70

Citizens Financial Group Inc.

251 67 33 83


293 62 38 112

Fifth Third Bancorp

330 59 41 135

Wells Fargo & Co.

705 59 41 292

Truist Financial Corp.

1,078 56 44 471

Discover Financial Services

247 55 45 111

U.S. Bancorp

1,213 52 48 577

American Express Co.

693 50 50 345

Northern Trust Corp.

319 46 54 171

JPMorgan Chase & Co.

6,166 45 55 3,388

M&T Bank Corp.

316 45 55 174

Citigroup Inc.

2,415 44 56 1,341

Ally Financial Inc.

190 38 62 117

Bank of America Corp.

4,176 38 62 2,605

Bank of New York Mellon Corp.

915 30 70 636

State Street Corp.

609 30 70 426

PNC Financial Services Group Inc.

1,789 28 72 1,295

Goldman Sachs Group Inc.

1,878 24 76 1,430

Morgan Stanley

2,405 23 77 1,854

Capital One Financial Corp.

332 14 86 286
Notes: 1) Common dividends are sourced from the third-quarter regulatory Y-9C reports, schedule HI-A item 11. 2) The estimated quarterly average 2020 net income (NI) equals the average of Bloomberg consensus estimate of net income for fourth-quarter plus the actual net income from the Y-9C reports for the first three quarters. 3) Permissible Q1 2021 share repurchase/NI (%) equals 100 minus common dividend payout ratio/NI (%). 4) Sorted by the highest common dividend payout ratio/NI (%) to the lowest.

Stress Burndown Analysis

One useful analytical exercise in the aftermath of the stress test results is to rank the banks by their capital declines, without taking into account their capital payout requests. To do so, we look at a bank's starting CET1 ratio and its minimum CET1 ratio during the nine quarters of the stress test. The smaller the decline from the beginning ratio to the minimum ratio (or burndown), the stronger the bank's capital and earnings position is relative to its risk, according to the Fed's stress test.

Given the unique features of the Fed conducting a second stress test this year, we compared the results in December with those in June (see table 3). A few things to note:

  • The burndown of capital for most banks under the December severely adverse and alternative severe scenarios was more severe than the June 2020 test due to the more stringent modelling assumptions.
  • That said, some banks showed a lower burndown in the December test versus June. The U.S.-domiciled banks that fall into this category are Capital One Financial, Goldman Sachs, Morgan Stanley, Ally, JPMorgan, Truist, and Regions.
  • Alternatively, some U.S.-domiciled banks fared worse in December's stress test versus June, with their capital burndown greater than 50 bps. These include M&T, Citizens Financial, Wells Fargo, Bank of America, Citigroup, Fifth Third, State Street, Northern Trust, Bank of New York Mellon, PNC, and U.S. Bancorp.
  • Of all the U.S. domiciled-banks, M&T's CET1 ratio came closest to the minimum, totaling 5.0% at the end of the Fed's stress period, versus a 4.5% regulatory required minimum.

Table 3

Dodd-Frank Act Stress Test Capital Burndown
--Common equity Tier 1 capital ratio--
2020 CCAR banks Holding company long-term rating Actual 2Q 2020 (%) Burndown December 2020 (basis points) severely adverse scenario Burndown December 2020 (basis points) alternative severe scenario Burndown June 2020 (basis points) severely adverse scenario
DB USA Corp.* NR 31.50 (1,170) (1,200) (780)
HSBC North America Holdings Inc.* NR 13.60 (810) (850) (570)

Capital One Financial Corp.§

BBB 12.40 (530) (500) (540)

BMO Financial Corp.

A+ 12.10 (510) (560) (590)

Goldman Sachs Group Inc.§

BBB+ 13.30 (480) (500) (630)

Credit Suisse Holdings (USA) Inc.

NR 21.40 (450) (430) (520)

M&T Bank Corp.*

A- 9.50 (450) (470) (120)
BNP Paribas USA Inc. NR 15.80 (430) (470) (500)

UBS Americas Holding LLC

A- 21.00 (430) (430) (420)

Morgan Stanley§

BBB+ 16.50 (410) (460) (510)

MUFG Americas Holdings Corp.

A- 14.50 (360) (380) (440)
RBC US Group Holdings LLC NR 16.10 (350) (370) (360)

Discover Financial Services

BBB- 11.70 (340) (210) (300)

Citizens Financial Group Inc.*

BBB+ 9.60 (330) (340) (290)

Ally Financial Inc.§

BBB- 10.10 (270) (280) (320)

Wells Fargo & Co.*

BBB+ 11.00 (270) (270) (200)
Barclays US LLC NR 17.30 (260) (210) (290)

JPMorgan Chase & Co.§

A- 12.40 (240) (240) (260)

Bank of America Corp.*

A- 11.60 (230) (240) (160)

Citigroup Inc.*

BBB+ 11.80 (220) (200) (150)

Fifth Third Bancorp*

BBB+ 9.70 (220) (220) (160)

Truist Financial Corp.§

A- 9.70 (190) (200) (210)

Regions Financial Corp.§

BBB+ 8.90 (180) (190) (240)

Huntington Bancshares Inc.

BBB+ 9.80 (180) (170) (140)

PNC Financial Services Group Inc.*

A- 11.30 (170) (170) (30)

U.S. Bancorp*

A+ 9.00 (140) (120) (20)


BBB+ 9.10 (140) (140) (140)

State Street Corp.*

A 12.30 (90) (80) (20)
TD Group US Holdings LLC* NR 16.30 (90) (70) 0

Northern Trust Corp.*

A+ 13.40 (80) (80) 10

Bank of New York Mellon Corp.*

A 12.70 (80) (50) (20)

American Express Co.

BBB+ 13.60 (10) 10 10

Santander Holdings USA Inc.

BBB+ 14.30 10 50 (140)
Participating bank holding companies - aggregate 12.20 (260) (250) (210)
Notes: Sorted by the highest burndown (Fed’s estimate of the change from the starting to the minimum CET1 ratio) to the lowest under severely adverse scenario. While the foreign bank IHCs are not rated, we do have ratings on their parent operating banks. *Capital burndown in December 2020 stress test (either under severely adverse or alternative severe scenario) was at least 50 basis points higher than the June 2020 stress test. §Capital burndown in December was lower than in June. NR--Not rated. N/A--Not applicable. Sources: Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Results and S&P Global Market Intelligence.

Loan Loss Rate Analysis

The aggregate loan loss rate in December's severely adverse scenario totaled 7.7% (see table 4), with credit cards (22.3%) and CRE (12.6%) the sectors with the highest amount of loan losses. In December's alternative severe scenario, the aggregate loss rate totaled 7.3% (credit card and CRE are 20.3% and 11.9%, respectively). This compares with June's severely adverse scenario, which showed a loan loss rate of 6.3%, with credit cards at 17.1% and CRE at 6.3%. All individual banks' aggregate projected loss rates rose under the new scenarios, with a few banks' loss rates almost doubling from where they were in June. Notably, the aggregate commercial real estate loss rate almost doubled, mirroring our concerns for this asset class (see "U.S. Banks Face Long-Term Risks To Their Commercial Real Estate Asset Quality," Nov. 16, 2020).

Table 4

Projected Loan Loss Rates
--Loan losses December 2020 stress test-- --Loan losses June 2020 stress test--
Bank holding company Severely adverse scenario Alternative severe scenario Severely adverse scenario

Discover Financial Services

21.3 19.5 17.0

Capital One Financial Corp.

17.0 15.9 15.5

American Express Co.

13.8 12.6 10.7
Barclays US LLC 13.8 12.6 11.0
HSBC North America Holdings Inc. 10.6 10.4 6.0

Goldman Sachs Group Inc.

10.1 10.0 8.1

M&T Bank Corp.

10.1 9.7 5.5

Santander Holdings USA Inc.

10.0 9.5 9.3

Fifth Third Bancorp

8.4 8.2 6.8

Citigroup Inc.

8.2 7.7 6.7

BMO Financial Corp.

7.6 7.5 6.4
BNP Paribas USA Inc. 7.6 7.3 7.0

U.S. Bancorp

7.6 7.3 5.8

JPMorgan Chase & Co.

7.3 7.0 6.6

Citizens Financial Group Inc.

7.0 6.8 5.6
DB USA Corp. 7.0 6.8 3.2

Ally Financial Inc.

6.9 6.6 6.4

Regions Financial Corp.

6.9 6.8 6.3

Huntington Bancshares Inc.

6.8 6.5 5.1
RBC US Group Holdings LLC 6.8 6.5 5.2
TD Group US Holdings LLC 6.6 6.3 5.9

PNC Financial Services Group Inc.

6.5 6.3 5.1

Wells Fargo & Co.

6.5 6.3 4.9

MUFG Americas Holdings Corp.

6.4 6.2 5.7

Truist Financial Corp.

6.3 6.1 5.1

Bank of America Corp.

6.1 5.8 4.7


5.9 5.7 5.3

Northern Trust Corp.

5.9 5.9 5.7

State Street Corp.

4.9 5.0 4.5

Morgan Stanley

4.4 4.4 3.5

Bank of New York Mellon Corp.

3.0 2.9 2.7

UBS Americas Holding LLC

2.0 1.9 2.0

Credit Suisse Holdings (USA) Inc.

1.7 1.6 0.9
Median loss rates of 33 participating firms 6.9 6.8 5.7
Total loss rates of 33 participating firms 7.7 7.3 6.3
Notes: Sorted by the highest loss rates to the lowest under severely adverse scenario December 2020 stress test. Source: Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Result.

Updated Loss Rate Assumptions

S&P Global Economics expects U.S. real GDP to contract 3.9% this year and grow a modest 4.2% in 2021 (slightly better than the September forecast, which assumed a 4.0% contraction in 2020 and 3.9% growth in 2021). Given somewhat greater stabilization than we had projected at the outset of the pandemic, and growing promise regarding vaccine distribution, we have lowered our loss rate assumption for our rated U.S. banks to 2.2% from our previous projection of 3% over the next two years. We expect charge-offs to pick up in 2021 and likely decelerate in 2022. Notably, through the first three quarters of 2020, all banks we rate have taken provisions of 1.2% of loans, which suggests they are already well-positioned to absorb a little over half of our projected loss rates.


U.S. Banks Generally Remain Resilient

The Fed's stress test results and our own analysis suggest that most U.S. banks are heading into 2021 with relatively solid balance sheets and decent pre-provision revenue, all things considered. The Fed's explicit approval of a resumption of share repurchases also aligns with the largely stable outlooks we have maintained on our ratings on the largest banks. Although there is still uncertainty, we believe the stable outlooks indicate why rated banks should be able to handle additional potential shocks in the aftermath of the shutdowns that began in March 2020. U.S. banks so far have been more resilient--in contrast to the distress they experienced a decade ago.


Table 5 summarizes the key features of December's severely adverse and alternative severe scenarios, as well as June's W-shaped scenario.

Table 5

Select Key Assumptions
--June 2020-- -December 2020--
W-shaped scenario Severely adverse scenario Alternative severe scenario
Real parameters
Peak unemployment rate (%) 16.00 12.5 11.0%, but 1.5 pp higher than SA by 3Q 2023
Peak-to-trough GDP decline (%) (12.40) -3.25% peak to trough in Q4 2021 -9% annualized rate decline in Q4 2020 then rising 2% in 2021
Max decline in housing prices (%) (28) (27) Similar to SA but steeper fall in regions with the highest price increases
Max decline in CRE prices (%) -35% also assumes high vacancy rates in hotel and retail (30) Similar to SA but steeper fall in regions with the highest price increases
Global market shock parameters
Interest rates Near zero, but long end of curve steepens over time Remain near zero through forecast period with the long end rising gradually Near zero, but long end of curve steepens a bit more than in SA
Peak spreads ('BBB' yields to Treasury) (%) 5.50 5.75 5.75% but remain wider for longer
Equity prices (%) (50) >-30 -50% gradual decline by end of stress period
Peak VIX 70 70 70, but a more gradual decline
SA--Severely adverse. Sources: Federal Reserve Board and S&P Global Ratings.

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Stuart Plesser, New York + 1 (212) 438 6870;
Secondary Contacts:Brendan Browne, CFA, New York + 1 (212) 438 7399;
Devi Aurora, New York + 1 (212) 438 3055;
Research Contributor:Kumar Vishal, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai

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