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As scheduled, in the last week of June, the Fed announces Stress Test results for the largest banks in the US. This year's stress test includes 31 banks participating in this rigorous test — up from 23 last year. The Stress Test aims to verify whether the reserve capital from these large banks can withstand the major economic shocks assumed by the Fed, under the legal requirements of the Dodd-Frank Act.
However, the stress test results only represent the “health” of the 31 largest banks with significant impact on the banking system (Systemically Important Banks). Meanwhile, the top concern for the banking system today is commercial real estate (CRE) losses that could broadly affect over 4000 small banks and regional banks remaining. Therefore, alongside the Stress Test results, Viet Hustler will also highlight the key points in FDIC's Q1 report on the US banking system.
Note: This week's macroeconomics article only summarizes a few important statistics in Stress Test Results from the Fed and FDIC Quarterly Report. The article does not include subjective opinions from Viet Hustler.
Stress Test: 31 large banks pass the challenge - CRE is not a challenge for this group of banks.
Basic information on 2024 Stress Test
Readers can learn more basic information about Stress Test and 2023 Stress Test results through Viet Hustler's previous article:
Stress Test checking whether large banks have sufficient capital to absorb losses in the worst economic conditions (assumed by the Fed)… to continue lending activities to households and businesses.
Specifically, the most stressful economic conditions set by the Fed are:
Unemployment rate: in the range of 6.3% to 10%
Real GDP growth: decline -8.5% from peak
House prices decline: -36% y/y
Value of commercial real estate (CRE) loans decline - 40% y/y
BBB bond yields rise sharply and equity investment values decline (as in the table below).
List of 31 large banks participating in this year's Stress Test:
Key results in 2024 Stress Test
The most important figure in the Stress Test report is the change CET1 ratio of banks in the worst economic scenario.
CET1 (Common capital equity tier 1) ratio is the Common Equity Tier 1 capital ratio (including high-quality liquid assets) held by the bank.
Stress-Test indicates: the aggregate CET1 ratio of 31 banks could drop -2.8% if the economy worsens
CET1 ratio aggregate of 31 banks is currently ~ 12.7% at the end of Q4/2023.
In the most severe economic conditions, the CET1 ratio could fall to 9.9% in 2024….
… and will recover to 10.4% at the end of the Stress Test period (Q1/2026).
This decline is not at an alarming level:
31 banks will still have enough capital to cover emerging losses (estimated up to -USD 685 billion in the worst economic conditions) while ensuring normal lending operations.
However, the decline level -2.8% CET1 ratio (from 12.7% to 9.9%) this year is much larger than the -2.5% level in 2023 (also the largest since 2018).
The main reasons for the aggregate CET1 ratio of these 31 banks declining -2.8% may come from 3 main factors:
(…. which are also the 3 biggest risks for large banks currently….)
High growth in credit card outstanding debt — accompanied by an increase in delinquent credit ratio ==> increasing expected losses on consumer credit loans.
Banks' corporate credit portfolios have shifted to riskier loans:
Proportion of investment grade corporate credits decreases;
While, proportion of high-risk corporate credit (non-investment grade) increases significantly;
=> causing the expected loss ratio to increase significantly.
Non-interest income decreases while non-interest expense increases
=> Making projected net non-interest income lower than before.
CRE loan risk (Commercial Real Estate loans) is not an issue for large banks:
This year's stress-test report mentions CRE losses (projected: -USD 77 billion in the worst economic conditions for 31 large banks) which is not a cause for concern.
However, Viet Hustler wants to emphasize that CRE losses will impact regional banks more than these large banks.
CRE debt accounts for up to 28.7% of small banks' assets, while only 6.5% of large banks' total assets - JPMorgan.
(and possibly even less for the 31 banks participating in the stress-test)
Forecast of large banks' performance in the worst economic scenario:
Projected total revenue, profits, and losses for the above 31 banks in Q1/2026 under the worst economic conditions as follows:
The largest potential losses from operational risks and costs of owning the banks' RE properties (both in the non-interest expenses category).
Next are losses from lending and leasing activities…
For losses from business activities (up to -USD 684 billion in the worst economic conditions):
The biggest risk comes from consumer credit losses (through credit cards) accounting for 26%
Bank loans could cause losses -USD 571.2 billion, equivalent to 7.1% of the total asset portfolio — in the worst economic scenario.
However, as Viet Hustler has emphasized, the 31 banks participating in the stress-test cannot represent more than 4500 banks in the US banking system.
Therefore, to gauge the health of the banking system, Viet Hustler also provides the following representative statistics for the US banking system from the FDIC's Q1/2024 report.
FDIC's Q1/2024 US Banks Performance Profile
FDIC insures deposits (deposit) at 4,568 commercial banks / deposit institutions across the US.
Quarterly, FDIC issues a summary report on the operations of these banks.
Below are some highlights of the US banking system in Q1/2024.
Operating Results
Income of 4,568 banks /deposit institutions:
In Q1/2024, net income of banks increased by: + USD 28.4 billion (reaching 64.2 billion USD Q1/2024).
This increase largely comes from the reduction in non-interest expense: down -22.5 billion USD (-13.3% Q/Q)
Part of it is due to FDIC reducing special assessment expense for the banking system: down by 12 billion USD.
(FYI: FDIC special assessment expense is the risk assessment fee for FDIC's bank deposit insurance)
Unrealized losses (unrealized loss) from bonds and debt increased:
Total unrealized losses (unrealized loss) in the banking system are -USD 516.5 billion in Q1/2024,
…. higher by USD 38.9 billion (+8.2% Q/Q) compared to the previous quarter.
This is the general situation since the end of 2022 due to the high interest rate environment following a series of tightening interest rate-monetary policies from the Fed.
Bank lending activity declined:
Total bank loans decreased by -USD 34.8 billion, (equivalent to -0.3% Q/Q growth) in Q1/2024.
Most of the decline in lending activity came from the largest banks.
Major portfolio declines from:
Seasonal factors: Q1 is the low season for credit card loans (-3.2% Q/Q)
Auto loans (-1.4% Q/Q).
Risks of the 4568-bank system via FDIC report
CRE investment portfolio: delinquent debt rising again for large banks
CRE accounts for a small portion of large banks' investment portfolios but the CRE delinquency rate is rising sharply for this group:
Large banks (total assets >250 billion USD) have delinquency rates up to 9% on non-owner-occupied real estate debt (investment-purpose real estate).
More banks are in trouble, but still only a small number
The number of troubled banks (“problem bank list”) increased to 63 in Q1/2024 (it was only 52 in Q4/2023).
“Problem bank list”: list of banks with weaknesses in finances, business operations and/or management – according to FDIC assessment
However, these banks currently account for only 1.4% of the total banks in the US managed by FDIC.
The insurance fund to insured deposit ratio is high compared to history but still below the peak
The balance in FDIC's Deposit Insurance Fund (DIF) is currently USD 125.3 billion – insurance for a total of USD 10,738 billion deposits at 4568 US banks.
Insurance fund value = 1.17% total insured amount – up from 2023 but still below the 2021-2022 peak.
CONCLUSION
Overall, looking at both reports: the Fed's Stress-Test and FDIC's Q1/2024 report, it can be said that there are not too many problems with the current US banking system.
Two highlights in this year's Stress-Test report compared to last year are:
1- The Fed's model projects that banks' CET1 capital could decline more sharply in the worst economic scenario:
CET1 ratio could drop -2.8% from current levels, (largest decline since 2018)
2- Stress-test clearly points out 3 risks that could cause large banks to incur losses, including:
High credit card balances + rising consumer credit delinquency rates ==> expected losses on consumer credit could rise significantly this year.
Banks' corporate credit portfolios are shifting to riskier loans (non-investment grade increasing).
Non-interest net income could decline due to non-interest income falling relative to expenses.
Meanwhile, the issues of 4568 deposit-insured banks by FDIC include:
The banking system's unrealized losses remain high — due to macroeconomic factors with the high interest rate environment!
Bank lending activity is slowing: with credit card loans and auto loans declining the most…
CRE debt accounts for a small proportion in large banks' investment portfolios but large banks' CRE delinquency rates are rising sharply…
The number of banks on FDIC's “problem bank list” increased in Q1/2024: but at least, no bank has failed yet!
Therefore, the above reports help us gauge the health of the current banking system to some extent.
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