It’s that time of the year again. That’s right, it’s March, time for the Federal Reserve’s annual Comprehensive Capital Analysis and Review of major financial institutions. Research firm Sterne Agee published an Industry Report on February 35th focusing on the upcoming Fed stress test and what it means to the banks involved.
SA analysts Terry McEvoy and Austin Nicholas give an overview of the Fed stress test process and offer their perspective on selected names in their big bank coverage universe. “With the press already reporting that both Deutsche Bank and Santander will likely fail the stress test we feel better about the prospects of all the others passing. If one or two other banks were to fail, it could be because of concentration issues…”
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More on the Fed stress test
As McEvoy and Nicholas point out, the goal of the CCAR is to make sure large banks have “robust, forward-looking capital planning processes” to ensure that they can remain solvent during times of economic and financial stress.
The report notes that 31 bank holding companies are participating this year and have submitted their capital plans to the Fed as of the first week of January.
The Fed sets up baseline, adverse, and severely adverse scenarios with 28 variables to determine the financial strength of every bank. The results of the Fed stress test results will be released on March 5, while the CCAR results will be released on March 11. The CCAR results include announcing the banks’ dividend and share buyback plans.
Bank payouts and performance
Sterne Agee covers 10 banks included in the Fed stress test. McEvoy and Nicholas note that they model 2015 dividend payout ratios of 30%, with total capital returns of 57%, including buyback assumptions. Total capital returned from 2Q14 to 1Q15 was an estimated 57%. Of interest, the median projected dividend increase for the 10 banks is 9% for 2015 relative to 9% and 16% in 2014 and 2013, respectively.
Exhibit 4 makes it clear bank stocks have beaten the S&P 500 in the two weeks leading up to the stress test results by 342 bps from 2011 through 2014. The SA analysts argue the sector could return to favor as the market looks for positive news regarding capital returns.
They note: “Banks with high relative capital payouts expected in 2015, lower exposure to the items mentioned below, and reasonable valuations are STI, USB and KEY in our view. Should history repeat itself we recommend active investors take profits after March 11 as bank stocks have underperformed the S&P 500 each of the last four years in the two weeks following CCAR.”