2023-06-29 09:21:30 ET
In the Federal Reserve's annual stress testing on the U.S.'s largest banks, Capital One Financial ( NYSE: COF ), Citizens Financial Group ( NYSE: CFG ), and Truist Financial ( NYSE: TFC ) had the most negative impact as they'll be required to hold onto more capital to protect against any potential downturn.
The level of the stress capital buffer, or SCB, is important for investors because the more money banks are required to set aside to handle any potential economic shocks, the less it can give back to shareholders in the form of dividends or stock buybacks.
As a result of the test, J.P. Morgan analyst Vivek Juneja downgraded Citizens Financial ( CFG ) to Neutral from Overweight. Its capital requirement will increase to an estimated 8.6% CET1 ratio, further pressuring its profitability, Juneja said.
By contrast, JPMorgan Chase ( NYSE: JPM ), Bank of America ( NYSE: BAC ) and Goldman Sachs ( NYSE: GS ) improved the most, Evercore ISI analyst Glenn Schorr pointed out in a note to clients. JPM's stress capital buffer fell 119 basis points, BofA's dropped by 90 bps, and Goldman's declined 88 bps.
On average, the banks' SCB improved by 14 bps even though the hypothetical recession in this year's stress test exerted harsher conditions than 2022's, Schorr said.
The SPDR S&P Bank ETF ( KBE ) rose 1.4% in Thursday premarket trading, and the SPDR S&P Regional Banking ETF ( KRE ) gained 1.5% , both outpacing the S&P 500, which is roughly flat.
Bank of America ( BAC ) screened best in DFAST (Dodd-Frank Act Stress Test) as it had the biggest increase in stressed preprovision net revenue, the second lowest loan loss rates of the Big Five Banks (Citi, JPMorgan, Bank of America, Goldman Sachs, Morgan Stanley), and the third largest AOCI (accumulated other comprehensive income) benefit, he said.
Citi ( NYSE: C ) was the only global systemically important bank (G-SIB) that saw its SCB increase, 25 bps due to lower stressed PPNR and higher credit card losses, Schorr pointed out.
Jefferies analyst Ken Usdin also highlighted Wells Fargo ( NYSE: WFC ), Morgan Stanley ( NYSE: MS ), M&T Bank ( NYSE: MTB ) and PNC Financial ( NYSE: PNC ) as poised to see their CET1 ratio requirements decline.
Still, investors can't read too much into how much banks can give back to shareholders, even with the relatively good performance in this year's Fed stress test. Usdin sees limited capital return activity in the near term as banks wait for regulatory clarity about the Basel III "endgame" and the Fed's holistic capital review.
"These upcoming regulations will likely lead to higher capital requirements for all banks above $100B of assets. Many banks have already pulled back on capital return in preparation for potential increases in requirements," Usdin said in a note.
The Basel III endgame process is expected to start on or around July 18th, Schorr said. These are standards set by the Basel Committee on Banking Supervision, part of the Bank for International Settlements.
Some analysts don't assign much importance to the Fed's test. "While it is important to know that these banks might be healthy, this test has nothing to do with why the three big banks [Silicon Valley Bank, Signature Bank, First Republic Bank] failed this year," wrote Odeon Capital's Dick Bove.
The stress test uses a hypothetical recession to evaluate the health of banks, in which interest rates go down and the value of securities and loans rise. But the recent bank failures were triggered by rising rates, falling asset values, and a rush to withdraw deposits. "Further rapid rises in interest rates can easily cause more bank failures," Bove said. "The stress test completely ignores this probability/possibility."
He emphasized the need for investors to evaluate each bank's balance sheet, one-by-one, before investing in any bank stock.
Oppenheimer's Chris Kotowski also took a skeptical view of the results. He considered the "exploratory market shock" section to be bizarre. "WFC with its comparatively tiny trading operations is going to have 37% more trading losses than BAC with its Merrill Lynch??? Really?" he asked. "In any case, we view Stress Test 2023 as a non-event for the stocks and continue to recommend BAC, C, GS, JPM, MS and USB."
More Views on Banks:
- Wells Fargo: A Top Tier Bank Trading at 0.95x BV
- Capital One: Why I Sold and Downgraded to Hold
- Goldman Sachs Looks Interesting, Yielding 3.18%, Going Into the Second Half of 2023
- PNC Financial: Now a Value Stock With a 4.9% Yield
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Capital One, Citizens Financial, Truist screen poorly in 2023 Fed stress test