Banks Biggest Stress Test Remains
For bank giants, the prospect of bond ratings downgrades or a worsening of the European debt crisis is a still imminent threat, even after stress tests results added to a 2012 bank stock rally.
JPMorgan, Bank of America (BAC) , Citigroup, Morgan Stanley (MS) and Goldman Sachs (GS) and all face a debt downgrade at Moody's, in addition to an ebbing European crisis, which could yet stall a rally.
Stress test results showed stronger than expected dividend and share repurchase programs at some banks, while others like Citigroup(C) failed to meet the Fed's tests, putting capital return plans up in smoke .
But post-stress test optimism may be dimmed by another highly anticipated event for banks: the conclusion of a Moody's ratings review that may lead to multi-notch ratings cuts at giant lenders. A strring of cuts could be a rally-killer after a near 20% surge in the KBW Bank Index (BKX) and a 8% Dow Jones Industrial Average rally in 2012. On Tuesday, an over 200 point rise fueled by stress test results put shares at multiyear highs .
In February, Moody's said that it is reviewing big bank debt, with the potential for a harsh ratings assessment to remind investors of the pessimism that swept over the sector last fall. That's because a new string of debt ratings cuts be costly after the previous round provided more of a dent to confidence.
If agencies like Moody's, Standard & Poor's and Fitch Ratings continue to reposition bank ratings, the moves could cost serious money, which wasn't something the Federal Reserve accounted for in its stress tests released on Tuesday.
The Fed tests asked banks to have a tier 1 common capital ratio of above 5% when accounting for capital return plans and a near apocalyptic set of market conditions in the U.S. Bank balance sheets were tested against a 21% drop in already battered housing prices, a 50% drop in still recovering stock markets and a surge in the unemployment rate to 13%, a level not seen since the Great Depression. That scenario would cost the 19 banks tested a total of $534 billion. Within that figure, the Fed assumed $116 billion in trading and counterparty credit losses at 6 large U.S. banks tied to global markets.
A European slowdown, while not quantified, is assumed by the Fed to impact the 6 banks it highlighted as tied to global markets, contributing to a portion of overall trading losses. The Fed assumes a European slowdown could trigger a fall in the value of private equity and derivative assets, while widening credit default swap spreads on banks and sovereigns.