Results from the Dodd-Frank Act supervisory stress test (DFAST) came out yesterday and all 31 bank holding companies (BHC) passed, but we still have to wait on results from the Comprehensive Capital Analysis and Review (CCAR) due March 11 before we find out about the banks’ capital return plans. There’s even a possibility that some banks will fail the CCAR yet again on qualitative grounds.
Zions could fail the CCAR yet again
The reason DFAST is seen as the easier stress test for banks to pass is that it assumes that the banks will use last year’s dividends (most would like to increase their dividends) and ignores buybacks completely. It’s also a strictly quantitative stress test – if your stressed capital ratios are high enough you get a pass – while the Federal Reserve can and has failed banks during the CCAR on qualitative grounds (eg risk management). So no one expected there to be an outright failure this year, but investors are still looking closely at this week’s results to give them better insight into what to expect on the eleventh.
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Zions is seen as being the most at risk for failing on qualitative grounds. Zions failed the DFAST last year (as well as the CCAR), and it’s expected to ask for a small increase in capital return if any at all, but it still had the lowest tier 1 common ratio in the severe adverse scenario with 5.1%, really just squeaking by. Zions also had the largest discrepancy between its own internal stress tests and the Fed results, which might cause the Fed to question the quality of the operational risk controls that it is supposed to have been working to improve since last year. Currently trading at $27.25, Zions stock price was basically unmoved by the news, but then considering the bank’s exposure to energy and the possibility of needing to increase reserves, investors shouldn’t have been expecting a big capital return anyways.
Analysts disagree on whether Citi will pass CCAR
Among the universal banks Citi had the biggest increase in its minimum Tier 1 common ratio, from 7.0 last year to 8.2 in this year’s test, and BMO Capital Markets analyst Peter Winter lists it as one of the banks where he expects to see a large increase in capital returns. He points out that Citi’s stress test results were within 17% of the Fed results, suggesting that the bank has a better grip on what the Fed is looking for than last year, and expects dividends to increase from $0.04 per share last year to $0.16 this year and $1.13 in 2016.
Winter realizes that many investors are still worries that Citi could fail the CCAR on qualitative grounds, but he is bullish and lists long Citi/short Wells Fargo as his favorite pre-CCAR trade. For contrast, Credit Suisse analysts Susan Roth Katzke and Moshe Orenbuch expect Citi (along with Zions, Bank of America, and M&T Bank) to simply not ask for a large capital return this year. Credit Suisse is projecting a capital deployment (dividends plus buybacks) of $5.6 billion from Citi, while Winter at BMO estimates $8.8 billion. The BMO estimate is clearly the outlier here – Citi fell 1.16% to $52.94 in trading today, so investors see the results as disappointing but not a disaster. JPMorgan also fell 1.73% in trading today to $60.93 because investors were similarly disappointed with its DFAST results.