Fed Kicks Off Awkward Week For Banks

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One of the nice things about last year's Fed bank stress tests was that they were released, and everyone was like "OMG Citi failed!!," and then we all calmed down and realized that all that meant was that Citi's capital return plans had failed, so it couldn't launch a big share buyback, but it wasn't going to be smashed into dust as a warning to its compatriots. That turned out to be cold comfort for Vikram Pandit but was soothing for the rest of us. This year, in part to avoid the Vikram thing, the rules have changed: today the straight-up stress test results were released, while the Fed will approve or reject capital return proposals next week, and there'll be a lot of weird disclosure gamesmanship in the interim. Early signs point to Citi being out of the doghouse, and Goldman possibly being in it.

Also Ally Bank failed, sorry! Legit failed, not failed pro forma for capital return. So, smashed into dust.

Here is a chart you may or may not find amusing:

This chart is intended to answer the question: how many a 1-in-100 terrible days would these banks need to have in order to get the Fed's estimated trading losses?1 The answer is somewhere between one and two hundred top-1%-terrible days between now and Q4 2014, which by my watch is seven quarters or ~440 trading days from now.

Are you reassured? I mean, don't be, nobody believes VaR, what are you nuts? The basic interpretation of this should be something like: the world looks scarier in the Fed's "adverse scenario" than it does in the banks' VaR estimates, not because the Fed's adverse scenario is banks having regular horrible days over and over again for six months, but because the adverse scenario involves tail risks and correlations that would make these VaR numbers useless. That's as it should be.

There's a potential advanced interpretation, which is something like: why does Goldman's value-at-risk look twice as risky as Citi's? Various possibilities present themselves, ranging from "different banks have different portfolios and the Fed stresses different types of risks differently to reflect their actual macroeconomic scenario," through "Goldman is better at optimizing VaR models to minimize risk-weighted assets than it is at optimizing for the Fed's adverse scenario," up to "the Fed is cutting Citi a break after last year's unpleasantness."2

Anyway the key stress test results are here:

With 5% tier 1 common and 3% tier 1 leverage ratios being particularly worthy goals for those seeking capital return. Note in particular the relatively lame performance of GS and MS, who both scrape close to the 5% minimum for tier 1 common. What those banks have in common, I suppose, is that they're not really banks; they're investment banks awkwardly shoehorned into banking regulation. I occasionally go around saying things like "traditional banking activities like lending are the riskiest activities!" but the Fed obviously disagrees:

Of the $462 billion of adverse-scenario losses among these eighteen banks, the Fed estimates that $97 billion will come from trading portfolios. Only five of those banks even have material trading portfolios.3 I suppose those five banks are a bit sadder about that fact today than they were yesterday.

Dodd-Frank Act Stress Test 2013: Supervisory Stress Test Methodology and Results [Fed]
Fed Stress Tests Show 17 of 18 Banks Weathering Severe Recession [Bloomberg]
Fed’s Stress Tests Point to Banks’ Improving Health [DealBook]
Stress test results: Banks could lose nearly half a trillion dollars [Fortune]
Goldman Sachs and Morgan Stanley Near Bottom of Stress Tests [NetNet / John Carney]
Goldman exposed to $20bn loss in a crisis

1.So this uses reported average 2012 VaR numbers from the banks' 10-Ks, grossing up 95% VaR numbers to 99% stupidly (NORMSINV(.99)/NORMSINV(.95)) where only 95% numbers are reported. The dark blue bars represent the Fed's "Trading and counterparty losses" divided by 99% VaR; the light blue bars represent "Trading and counterparty losses" plus "Realized losses/gains on securities (AFS/HTM)" divided by VaR. Some calculations and references are here. Because of differences in how these things are reported, who puts what credit exposures where, how hedging VaRs etc. are calculated, these things are to some approximation meaningless, but whatever.

2.These answers are all undermined by the laziness of my math, which is really atrociously lazy. If you wanted to, you could try to actually, like, break out the Fed's stress scenarios and their impact on credit, rates, equities, etc.; compare those to the components of VaR, do a better job of identifying trading vs. loan/etc. VaR in the banks' reports, etc. etc. Or you could not. I didn't.

3.Oh, six, Wells Fargo you can come too, why not.


Citi Will Try The Stress Test Again With A $9bn Stock Buyback

More stress tests, bleargh. I guess the news is that Citi "failed", though I can't get all that excited by that because it didn't exactly "fail" in the sense of now it's being forced to raise capital / broken up / burned to the ground. Instead it failed assuming it follows the capital plan it submitted to the Fed, which is clearly a capital-lowering rather than capital-raising plan. I ballpark it at $10bn of share repurchases and dividends,* which is ... well, it's pretty big for Citi. So they can just not do that then. Or not do quite as much of that, which seems to be their plan: In light of the Federal Reserve’s actions, Citi will submit a revised Capital Plan to the Federal Reserve later this year, as required by the applicable regulations. The Federal Reserve advised Citi that it has no objection to our continuing the existing dividend levels on our preferred stock and our common stock, and we plan to do so, subject to approval by the Board of Directors each quarter. The Federal Reserve also advised that it has no objection to Citi redeeming certain series of outstanding trust preferred securities, as Citi proposed in its Capital Plan. We plan to engage further with the Federal Reserve to understand their new stress loss models. We strongly encourage the public release of these models and the associated benchmarks and assumptions. We believe greater transparency in this process will best serve all banking institutions and their shareholders as well as the international regulatory community and market participants, and will encourage a level playing field globally. There are at least two ha! moments in that snotty last paragraph. First there's the fact that the Fed had planned to release the stress test results on Thursday and got gun-jumped by Jamie Dimon. So much for Fed transparency. But also, specifically, as people are all running around suing each other about the Fed maybe kind of encouraging bank CEOs to hide material information from investors, it is odd that the Fed would have the stress test results and sit on them for two days. Imagine the scenario where Jamie Dimon, Vikram Pandit, and the Fed all know that JPM passed and was going to do a largeish buyback, while Citi failed and was going to do a ... I guess somewhat smaller buyback - and they didn't tell anyone from today until Thursday. If you sold JPM to buy C today, wouldn't you be kind of annoyed?**