HSBC HSBC Holdings PLC

By Andrew Ackerman and David Benoit 

The Federal Reserve said Friday that the largest U.S. banks remain strong enough to survive the coronavirus crisis but warned that a prolonged economic downturn could saddle them with hundreds of billions of dollars in losses on soured loans.

The Fed also said it would allow the banks to restart share buybacks but that it would, at least in the first quarter, restrict the amount. It said it would continue to restrict dividend payouts.

Under two hypothetical scenarios, in which unemployment remains high and the economy doesn't bounce back for several quarters, the 33 largest U.S. banks could be hit with as much as $600 billion in loan losses, the Fed said in the latest iteration of its stress test. That would erode the capital buffers meant to keep them on sound financial footing, the central bank said.

Designed to gauge the health of the nation's banks, the stress tests were expanded this year to study the effect of the downturn brought on by the coronavirus pandemic.

Earlier this year, the Fed placed restrictions on the biggest banks' dividend payouts and share buybacks, a move to preserve capital in an unsettled economy. At that time, the Fed stopped all buybacks and said dividends couldn't exceed a bank's recent profits. The Fed in September extended the restrictions through the end of this year.

On Friday, the Fed said the banks could restart making repurchases in the first quarter, but still can't return to shareholders more than they have been making in profit over the past year. The aggregate dividends and repurchases can't exceed the average quarterly profit from the four most recent quarters.

Randal Quarles, the Fed's vice chairman of supervision, said the banking system "has been a source of strength during the past year."

"Today's stress test results confirm that large banks could continue to lend to households and businesses even during a sharply adverse future turn in the economy," Mr. Quarles said in a statement.

In an initial round of stress tests, the Fed said in June that U.S. banks were strong enough to withstand the crisis but restricted dividend payouts and buybacks to make sure they stayed that way. Those tests, which the banks submitted in early April, reflected hypothetical downturns that were crafted before the onslaught of the coronavirus pandemic. The Fed subsequently added three extreme scenarios to the initial round of stress tests, but only released aggregate, and not individual, results of those tests.

The results released Friday reflect a second round of tests after the Fed required banks to resubmit updated capital plans to reflect the coronavirus crisis. Unlike in the earlier set of tests, the Fed released the results for each bank.

Under both hypothetical scenarios, each firm met its risk-based capital requirements. All but one firm, HSBC Holdings PLC, remained above the leverage requirements, the central bank said.

The Fed said both scenarios for the fall tests weren't forecasts and are significantly more severe than most current baseline projections for the path of the U.S. economy.

The banks have been preparing for potential loan losses, putting aside billions of dollars in the first half of the year. The big banks have added more than $100 billion in loan-loss reserves, the Fed said, a move that fueled an increase in their capital cushions. A key metric known as the common-equity Tier 1 ratio, which is a measure of high-quality capital as a share of risk-weighted assets, increased from 12% in the first quarter to 12.7% at the end of September for the largest lenders.

But the banks slowed reserve building in the third quarter when executives said they felt prepared for steep losses. Analysts began anticipating that they would be freed by regulators to start returning capital.

After the results were released, JPMorgan Chase & Co. announced it would repurchase $30 billion in stock and would start in the first quarter. Its shares rose 5.1% in after-hours trading Friday. Other banks climbed as well, with Citigroup Inc. up 5.4%.

The decision regarding capital distributions generated a dissent from Lael Brainard, an Obama appointee on the Fed board, who said the restrictions are too loose.

"Today's action nearly doubles the amount of capital permitted to be paid out relative to last quarter," she said in a statement. "Prudence would call for more modest payouts to preserve lending to households and borrowers during an exceptionally challenging winter."

Write to Andrew Ackerman at andrew.ackerman@wsj.com and David Benoit at david.benoit@wsj.com

(END) Dow Jones Newswires

December 18, 2020 18:17 ET (23:17 GMT)

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