Big U.S. banks passed the Fed’s stress test—but there’s a ‘looming risk,’ says former Fed official

In a welcome bit of news for the financial sector, the biggest banks in the U.S. all passed the Federal Reserve Board’s annual stress test. According to the Fed, the 23 banks subject to the test—including giants Citigroup, Bank of America, and JPMorgan Chase—are poised to weather a severe recession while continuing to lend to households and businesses.

All of the banks tested remained above their minimum capital requirements during a hypothetical recession that resulted in projected losses of $541 billion, the results found. In a statement, Michael S. Barr, vice chair for supervision, greeted the results in a measured fashion.

“We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses,” said Barr.

His comment suggests it is too soon to predict smooth sailing ahead for the banking sector. For additional insight, I talked with Mark T. Williams, a former Federal Reserve Bank examiner, who’s currently on the finance faculty at Boston University Questrom School of Business. He flagged a lurking danger.

“It’s a positive sign that the big 23 banks passed the stress test,” Williams said. “But this is just a stress test for the macroeconomy. And it wasn’t that the stress test gave a clean bill of health. [It] illuminated that commercial real estate risk within these big banks is significant. If we do go into recession, these 23 banks hold 20% of all commercial real estate and that’s offices, downtown buildings—that is a looming risk.”

The stress test included a hypothetical situation of a global recession with a 40% decline in commercial real estate prices, a substantial increase in office vacancies, and a 38% decline in house prices. In this scenario, the unemployment rate also rises by 6.4 percentage points to a peak of 10% and economic output declines commensurately.

‘They let that slip a bit in the regulatory oversight’

After the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act to prevent excessive risk-taking by banks. Then in 2018, a bill was passed that raised the threshold from $50 billion in assets to $250 billion in assets for when companies qualify as a “systemically important financial institution” requiring the stress testing process. 

“A rule called Standardized Liquidity Ratio gets waived for the mid-sized banks, meaning they can hold less liquid capital than for the top tier lenders,” Fortune’s Shawn Tully writes in a recent report. And “Silicon Valley Bank didn’t fulfill the $100 billion mark in average assets until the end of 2021, and therefore wasn’t included in the 2022 test, nor had it ever endured a Fed exam.” And crucially, the Fed’s “severe stress” scenarios completely missed the huge rise in rates, Tully writes.

“I think the Fed has fulfilled its duty with the largest banks, and made sure since 2008, they had been well capitalized,” Williams said. But after the collapse of SVB, Signature Bank, and First Republic Bank, the Fed’s “focus is clearly on the regional and smaller banks because they let that slip a bit in the regulatory oversight,” Williams said. 

Due to SVB’s collapse in March, CFOs began facing difficult questions from their boards. During Fortune’s Most Powerful Women Next Gen Summit last month, Dayna Quanbeck, Rothy’s CFO and COO, explained how the company was directly impacted. 

“I had diversified cash parked at SVB,” Quanbeck said. “And that was a heartbreaking moment because you think you’re doing the right thing by diversifying and parking cash to keep it safe.” 

She continued: “The irony is that we also had safe cash parked at First Republic. So, what you should take away is that I picked the wrong safe banks. But we had our concentration account at JPMorgan.”

“Perhaps CFOs, in particular, are feeling that probably they’re not getting the level of service they had with the regional banks,” Williams said. “So they have to weigh that with the safety of these bigger banks.”

The Fed’s stress test also incorporated market change in interest rates on trading portfolios for the big banks, Williams said. “The banks did fare well,” he said. “It proves that further interest rate shocks, at least in that specific area, won’t actually negatively impact the biggest banks.” 

U.S. Federal Reserve Chair Jerome Powell said on Thursday in Madrid at the Bank of Spain that interest rates may be raised “two or more times by the end of the year.” 

And that won’t be a hypothetical stress test. 

In recognition of the July 4 holiday, the next CFO Daily will be in your inbox on Wednesday, July 5. See you next week.

Sheryl Estrada
sheryl.estrada@fortune.com

Big deal

A new report by S&P Global Market Intelligence found that default risk for the S&P 500 ticked slightly higher approaching the end of the second quarter. The median probability of default for S&P 500 companies was 3.91% as of June 28, up from 3.84% on March 31, according to the Risk Gauge model. The scores are representative of the median odds of default on debt within a year, based on financial reports and the volatility of share prices for public companies in the index, according to the report.

Going deeper

Here are a few Fortune weekend reads:

"Fortune 500 companies including Microsoft and Salesforce react to the Supreme Court striking down affirmative action: ‘Our commitment to equality doesn’t waver’" by Trey Williams and Paige McGlauflin 

"Databricks says it’s buying MosaicML in a bid to ‘democratize A.I.’" by Luisa Beltran

"Fridays in the office are ‘dead forever’ according to one of New York’s biggest commercial landlords—and Mondays are ‘touch and go’" by Eleanor Pringle 

"Your ultimate guide to getting a good night’s sleep" by Alexa Mikhail 

Leaderboard

Some notable moves:

Jeffrey C. Campbell, vice chairman and CFO at American Express Company (NYSE: AXP) announced that has decided to retire from the company, effective Aug. 14, 2023. Christophe Le Caillec, deputy CFO will succeed him as CFO. Campbell will remain with American Express as vice chairman until March 2024. Campbell joined American Express as CFO in 2013. Le Caillec has had a 25-year career at American Express. In his current role as Deputy CFO, he leads the corporate planning team, as well as risk, technology, and the Global Services Group Finance functions.

Mats Backman was named CFO at The Volvo Group, and a member of the executive board. Backman will succeed Jan Ytterberg, who will continue as a Volvo Group senior advisor. Backman has been the CFO for companies such as Sandvik, Autoliv, and Veoneer. Backman will take on his new position during the second half of 2023. The exact date is yet to be decided, according to the company.

Lea Daniels Knight was named EVP and CFO at Integra LifeSciences Holdings Corporation (Nasdaq: IART), effective June 28. Most recently, Knight served as the EVP of business finance for Booz Allen Hamilton. Before that, she worked at Johnson & Johnson for 18 years, assuming finance roles with increasing responsibility, including as CFO of Johnson & Johnson’s North American pharmaceuticals business. 

Kacy Irwin was named associate commissioner and CFO at the West Coast Conference (WCC), a collegiate athletic conference affiliated with NCAA Division I, effective July 24. Irwin comes to the WCC after an eight-year tenure at the University of California, Berkeley. She most recently served as Cal’s assistant athletics director for financial operations and athletics gender equity. Before her arrival in Berkeley, Irwin worked at Columbia University, as the athletics business manager of travel operations after previously serving as the assistant director of facilities operations.

Rodney D. Gray was named SVP and CFO at Enerflex Ltd. (NYSE: EFXT), effective July 1. Gray will be responsible for Enerflex's financial reporting, treasury, tax, internal audit, corporate development, and capital market functions and will support the company's strategic and capital allocation decisions. He has over 30 years of experience in the energy industry, including the last nine years with Baytex Energy Corp., serving most recently as EVP and CFO.

Jonathan Root was named CFO at Harley-Davidson, Inc. (NYSE: HOG), effective immediately. Root is currently SVP of Harley-Davidson Financial Services (HDFS), and has overseen the global HDFS business as president of Eaglemark Savings Bank, president of Harley-Davidson Insurance, and president of all other HDFS subsidiaries. He joined HDFS in 2011 and has held multiple roles across the company.

Michael (“Mike”) Hynes was named CFO at Noodles & Company (Nasdaq: NDLS), effective July 24. Hynes brings nearly 25 years of finance and accounting experience to Noodles & Company. He held several roles in finance and accounting since he joined Ruth’s Hospitality Group in 2008. Most recently, he spent three years as VP of finance and accounting for Ruth’s Chris, a fine-dining steakhouse. 

Overheard

"What I do know is that talent is created equally, opportunity is not. And so we will all do our part to make sure that every young talent knows that they can achieve their full potential in this country."

—Thasunda Brown Duckett, CEO of TIAA, said during Essence Fest in New Orleans on Thursday in response to the U.S. Supreme Court's ruling to overturn affirmative action at U.S. colleges and universities, Fortune reported.