34 Participating Banks Emerge Triumphant In Stress Test 2017

Following the release of the Dodd-Frank Act supervisory stress test 2017 (DFAST 2017) results last week, the Federal Reserve approved the capital plans of all 34 financial institutions participated in the Comprehensive Capital Analysis and Review (CCAR). However, the capital plan of Capital One Financial Corporation (NYSE:COF) (NYSE:C) received conditional consent on resubmission within six months.

The Fed’s nod to all the major U.S. banks reflects stability in the banking system to a great extent. All the bank holding companies (BHCs), with $50 billion or more in total consolidated assets, are part of DFAST 2017. Notably, in seven years of annual ‘stress tests’, this is the first time that all participating banks have received the Fed’s approval for capital plans.

Almost all major banks ended the day in green following the positive results. The banks, now, have the privilege to raise dividends and buy back shares. Amid concerns that banks might not have sufficient capital to counter another financial crisis, the financial institutions were asked to submit their capital plans to the Fed. The banks were further intimated that payment of higher dividends will be restricted if they fail to meet the requirement of 4.5% Common Equity Tier 1 (CET1) capital ratio, among other requirements.

Notably, the participating banks in the tests are being allowed to pay out 100% of their estimated net earnings, over the next four quarters. However, the percentage is greater than 65%, which was allowed last year. For the first time since the 2008 financial crisis, banks have been permitted to deploy full annual profit to shareholders.

Root of the Capital Rules

Currently authorized under the Dodd-Frank financial-services law, these stress tests were introduced after the 2008 financial crisis. During the economic downturn, big financial institutions like Lehman Brothers collapsed, while several others were on the verge of a meltdown. Such a situation compelled the U.S. government to infuse billions of dollars into credit markets and save the entire financial system from crumbling. Stress tests have been annually conducted since 2009.

The Federal Reserve’s latest stress test scenario projections include input data supplied by the 34 banks participating in DFAST 2017, as well as models created by the regulatory staff and evaluated by a group of Fed economists and analysts. Moreover, the Fed's stress test was conducted to find out whether the banks have enough capital to survive another financial crisis, including a hypothetically 10% unemployment rate, more than 40% fall in stock prices, 35% drop in commercial real estate prices, more than 25% drop in housing prices, along with an economic downturn in developing Asia and a sharp rise in market volatility.

Additionally, severe recession in the UK, Europe and Japan was featured. The tests evaluate the losses expected for each bank with its capital.

Under the most severe scenario, the 34 banks would suffer $383 billion in loan losses, down from $526 billion in losses recorded by 33 banks in 2016. Notably, projected losses included $100 billion from credit card loans for the banks, at an equal level with commercial and industrial loans losses, for the first time. Therefore, both these categories constitute around 52% of the total projected loan losses worth $383 billion.

In aggregate, Common Equity Tier 1 (CET1) capital ratio would decline from an actual 12.5% in fourth-quarter 2016 to a post-stress level of 9.2% at the end of 2017. However, the figure is well above the 4.5% minimum mark set by regulators.

Banks that Aced

Wells Fargo & Company (NYSE:WFC) , Citigroup Inc. (NYSE:C) , Fifth Third Bancorp (NASDAQ:FITB) , Comerica Incorporated (NYSE:CMA) , KeyCorp (NYSE:KEY) , M&T Bank Corporation (NYSE:MTB) , JPMorgan Chase & Co. (NYSE:JPM) , Bank of America (NYSE:BAC) Corporation (NYSE:C) , U.S. Bancorp (NYSE:USB) and The PNC Financial Services Group, Inc. (NYSE:PNC) are among the major banks which received clearance from the Fed to raise their dividends or repurchase shares.

Among these, Comerica, KeyCorp and M&T Bank currently carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Recovery on the Way

This, however, is not the final round. Major banks will have to undergo the Fed’s stress test once every year, though under Trump’s administration it might be once in two years. These tests help increase the weak capital levels of banks, which are a looming threat to the economy. In addition, these could eventually translate into lesser involvement of the taxpayers’ money for bailing out troubled financial institutions.

Nevertheless, the approval from the Federal Reserve to increase dividend payment and accelerate the share buyback program will definitely help banks attract more investments, moving ahead.

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