Nearly all the largest U.S. banks have passed the Fed’s annual stress tests unconditionally this year—meaning, these banks are deemed fit to ward off financial stresses or crises and are eligible to raise payouts to their shareholders given their present capital stock and risk control practices.
As part of the Dodd-Frank Act, stress tests conducted by the Fed present hypothetical scenarios for banks to run through to test their mettle. According to The Wall Street Journal, this year’s testing scenario was reportedly more severe assuming the following—U.S. unemployment rate soaring to 10% with a plunging stock market reduced to half of its value and Treasury yields turning negative. Although banks are estimated to collectively lose $385 billion on loans in this worst case scenario, most of them have been evaluated to have sufficient capital cushion and risk management tools to combat the crises. Other, less harsh, scenarios included a minor U.S. recession with mild deflation, and a benchmark reflecting average projections of economists.
Passing the test with flying colors, institutions like Bank of America and Citigroup could heave a sigh of relief, having received unconditional approvals in 2015 and 2014 respectively. Following the test results, Citigroup announced a notable hike in quarterly dividends from 5 cents to 16 cents along with a share repurchase of around $8.6 billion. Bank of America plans to raise payouts to 7.5 cents from 5 cents and buy back $5 billion equity. JPMorgan Chase & Co. has decided to repurchase $10.6 billion of shares, up from last year’s announced $6.4 billion.
Of the 33 banks reviewed, the only ones not to fully pass the tests were Morgan Stanley and the U.S. subsidiaries of Deutsche Bank AG and Banco Santander; the latter two failed while Morgan Stanley received a conditional nod from the Fed to raise shareholder dividends. The Fed’s main gripes with these three banks were inadequate capital planning and risk management processes. Nevertheless, the banks’ capital ratios were still well above the required minimum.
Even as it prepares to meet the conditions laid down by the Fed to improve its capital management and internal control practices, Morgan Stanley is set to pay dividends of 20 cents (up from 15 cents) and ramp up share buybacks to $3.5 billion for the coming four quarters (from the preceding period’s $2.5 billion).
Bottom Line for Investors
With more than 90% of the large U.S. banks passing the stress tests, this could create a boost for U.S. banking stocks, bolstered by dividend raises and share repurchases already announced by some of the largest financial firms.
The test results couldn’t have come at a better time. Even as markets grapple with global risks, the tests reaffirm the U.S. banking system’s resilience (even under the most extreme test scenarios)—perhaps this is the most comforting proof of the U.S. economy’s sturdy fundamentals.
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