Can Banks Pass the “Ultimate” Stress Test?


The banking industry has shown it can weather economic downturns relative to the financial crisis years – even under the toughest stress testing scenarios. But how prepared is it to withstand a lingering recession escalated by the COVID-19 pandemic? To find out, we ran a severe adverse Dodd-Frank Act Stress Test (DFAST) to explore the impact a deep recession and two years of losses might have on banks’ capital levels, buybacks, dividend payouts, and valuations.

Gerard Cassidy authored the research report “U.S. Banks Feel the Burn 2020”. For more information about the full report or to access an Interactive Model that allows you to run your own testing scenario and input your own base-case assumptions, please contact your RBC sales representative.

We’ve shared some key insights from the results of our research findings below.

Report Key Takeaways:

 

Banks are well-positioned to handle “the burn”

Our research shows that banks would take a hard hit from a severely adverse scenario--but appear to be in a good position to stand up to a solid economic “one-two punch” accelerated by the pandemic. 

Assuming either bank-specific loss scenarios or a 5.7% average cumulative loss over the next two years, banks’ capital strength would decline. However, most can still maintain strong liquidity levels and meet common and preferred dividend requirements.    

 

Valuations hold up under a sharp market sell off

Banks’ book and tangible value will also hold up well during an assumed sharp market sell off and extremely stressed conditions.

Our analysis of “burndown” values reveals that banks would trade at 82% of book and 115% of tangible book value in these situations.

 

Banks sail through an extreme stress testing scenario

Overall, we believe that banks are in a solid position to handle a prolonged economic spiral accelerated by the COVID-19 pandemic.

Although they will clearly experience losses driven by declines in liquidity, we don’t expect it to impact their credit or balance sheet strength significantly.

Gerard Cassidy, Jon Arfstrom, and Steven Duong authored the U.S. Banks: Feel the Burn Report. For more information about the full report, please contact your RBC sales representative.

 

Published March 26, 2020


Gerard Cassidy, Jon Arfstrom & Steven Duong


BankingCoronavirusFinancial Services

Subscribe Today

Get the latest insights from RBC Capital Markets delivered to your inbox.