Are Banks a "Buy" After Stress Tests? - Real Time Insight

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The Federal Reserve released the results of the latest round of stress tests yesterday. 15 out of 19 banks tested passed the test, paving the way for the strong banks to announce hike in dividends and buy-back of shares.

Stress tests formally referred to as the Comprehensive Capital Assessment and Review are basically used by the supervisory authorities to determine whether the institutions had sufficient capital to withstand worse than expected downturn in the economic conditions.

The latest stress tests were "more stressful" than the earlier ones. The hypothetical stress scenario assumed the unemployment rate peaking at over 13%, US equity prices falling by 50% and US housing prices falling by moiré than 20%, in addition to economic slowdown in Europe and Asia.

Even before the results came in, JPMorgan announced that it would raise its quarterly dividend by 5 cents, and buy back $15 billion of its stock through 2013. That probably forced the Fed to announce the results two days ahead of schedule.

Stress tests clearly show that some banks are in a better financial position now and will most likely to increase their market share. Banks like JPMorgan ( JPM ), Wells Fargo ( WFC ), BNY Mellon ( BK ), State Street Corporation ( STT ) US Bancorp ( USB ), and American Express ( AXP) posted strong results, while Ally Financial, the former GMAC bank was the worst performing one, being the only one to fall short of minimum capital requirements without any capital plans. Citi ( C ) and SunTrust Bank ( STI ) and Met Financial ( MET ) had met the minimum capital requirements, but their capital plans were rejected by the Fed.

US banks have certainly come a long way since the crisis. They are much better capitalized with more sound risk management systems. Also, as US economy is on the slow improvement path, while Euro region is still struggling, the US banks are in a much better shape than their European counterparts. But some of the big ones are exposed to their European counterparts.

Also, higher regulatory costs and ultra-low interest environment will continue to hurt the profitability in near future. And banks still have a lot of risky mortgages on their balance sheets.

The Financial Select Sector ETF ( XLF ), which tracks broader group of financial stocks rallied 4% after the results but is struggling to maintain that level today. Overall this ETF has returned more than 18% year-to-date as the investors returned to take advantage of attractive valuation after the steep sell-off last year (negative 17% return).

Do you think that the banks have further room to run this year?

AMER EXPRESS CO ( AXP ): Free Stock Analysis Report

BANK OF NY MELL ( BK ): Free Stock Analysis Report

CITIGROUP INC ( C ): Free Stock Analysis Report

JPMORGAN CHASE ( JPM ): Free Stock Analysis Report

METLIFE INC (MET): Free Stock Analysis Report

SUNTRUST BKS (STI): Free Stock Analysis Report

STATE ST CORP (STT): Free Stock Analysis Report

US BANCORP ( USB ): Free Stock Analysis Report

WELLS FARGO-NEW (WFC): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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