What a difference five years makes.
It wasn't so long ago that all of the largest lenders in the U.S. were either in search of life saving financial support or on the verge of accepting billions in buffer capital that the government shoved into bank coffers as part of its Troubled Asset Relief Program. Now, banks expect that they will be able to maintain minimum capital ratios generally in excess of 9%, in the event of another market crash and severe recession over the next two years. Many even expect to remain profitable.
Stress test results released by large lenders on September 15 indicate a double-edged sword. There is no denying that firms such as Morgan Stanley (MS - Get Report) have transformed their business and are in a far healthier state after barely surviving the 2008 financial crisis. However, as expectations continue to rise for the banking industry's performance during a next bout of economic tumult, investors and C-Suites may be returning to the state of collective overconfidence that plagued the industry five years ago.
Morgan Stanley, US Bancorp (USB) and PNC Financial (PNC) now expect to report a profit in the next crisis. Last year Morgan Stanley forecast a stressed loss of $12.6 billion, however, those projections were before the firm took control of brokerage Morgan Stanley Smith Barney. JPMorgan (JPM - Get Report) expects to report a minimal $300,000.00 loss in the next crisis while Bank of America (BAC - Get Report) and Citigroup (C - Get Report) have both dramatically reduced their stressed loss forecasts.
Optimism isn't uniform across the banking sector.
Goldman Sachs (GS - Get Report) expects to report large losses in a time of crisis, a contrast to its more wealth-management oriented competitor Morgan Stanley. Wells Fargo, meanwhile, increased its expected loss to $3.8 billion as a result of lower pre-provision net revenue. The nation's largest mortgage lender still expects loan losses on its mortgage and commercial lending operations to be far lower than those projected by the Fed in its 2013 Comprehensive Capital Analysis and Review (CCAR).
Indeed, it is troubling that there is a large divergence between expected losses in banks' internal stress tests versus those made by the Federal Reserve in its annual CCAR. Consider that while JPMorgan expects minimal losses in a stressed environment, the Fed's last CCAR projected $32.2 billion in losses. It forecast far higher losses on the bank's loans and activity. The same holds true at Bank of America and, to a lesser extent, Citigroup.
Overall, the Fed projects that the nation's four largest banks would lose nearly $140 billion in a time of crisis, while internal estimates released by those banks on Monday only forecast about $50 billion in losses. Analysts generally believe the next round of stress tests from the Fed in March of 2014 will move closer to banking industry estimates, instead of vice versa.
"While capital standards lack uniform harmonization and will likely increase over the foreseeable future, we believe that today's relatively punitive capital levels will likely subside over time as the industry continues to build capital and the associated risks and economic landscape continue to change," Todd Hagerman, a Sterne Agee banking analyst wrote in a Tuesday client note. Analysts see rising forecasts of banking sector net income during a stressed environment as reinforcing expectations that firms will be able to increase their dividend and share buybacks in coming years.
"Our two main observations are that capital ratios now appear even higher than previously estimated. And second that several banks, in particular BAC, C, PNC and MS, now estimate their net income during a stressed scenario will be stronger," Richard Staite, a banking analyst at Atlantic Equities, wrote in a Tuesday client note.