Big Banks Pass Fed's "Stress Test": 3 Top Winners

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The Federal Reserve released the first round of its annual "stress test" results, mandated by the Dodd-Frank regulation. The findings have been encouraging, with all the banks appearing to have sufficient capital balances, which will help them to keep lending even at times of a severe recession. The results mark the third straight year of all firms fulfilling the minimum requirements in the tests' first phase. Goldman Sachs Group Inc GS , CIT Group Inc. CIT and Regions Financial Corp RF , particularly, are expected to be among the big winners that have higher than 100% payout ratios.

The results come at a time when the Fed forges on with the 25-basis point (bps) rate hike amid inflation worries, while the Trump administration is expected to push for lesser banking regulations. Banking on such positive developments, investing in sound bank stocks that have passed the litmus test will be judicious.

Cash Payouts Likely to Increase Manifold

Big banks have enough capital buffers to keep on trading through an economic meltdown, as per the Fed. They can withstand a situation where unemployment rate doubles and the broader equity market loses almost half of its value. The central bank estimated that the banking sector will bear up to $493 billion in losses in case of a downturn, but, officials still believe that the banks would emerge from the crisis "well capitalized", with cushions for shareholder funding well above the Fed's minimum requirement.

UBS analysts projected that the four biggest banks by asset size, JPMorgan Chase & Co. JPM , Bank of America Corp BAC , Citigroup Inc C and Wells Fargo & Co WFC will be able to return a net of $59.8 billion, which is poised to rise to $72.3 billion in 2018, as payouts to shareholders. According to Goldman Sachs analysts, Regions Financial, Citi and Discover Financial Services DFS , may return 124%, 124% and 114% of their annual earnings to shareholders, respectively.

As per Keefe, Bruyette & Woods (KBW), some of the big winners in terms of payout ratios include Goldman and CIT Group, with forecasted payout ratios of 136% and 157%, respectively. KBW added that Goldman "may not have the capacity to meet our bullish capital return forecast, but the capital buffer in the stress test may be enough to meet the consensus forecast for capital return".

Banks Well Poised to Meet Financial Obligations

During this first phase of the annual stress test, all thirty four of the largest banks "passed" having more than minimum capital and leverage ratios under severe adverse situations. The results covered the entire spectrum of the "Dodd-Frank Act Stress Test", which mostly measures the bank's capital under stress in the nine quarters.

When it comes to assessing the ability of a bank to meets its financial obligations, Morgan Stanley's 3.8% leverage ratio turned out to be the lowest, though it cleared the minimum threshold of 3%, as per Bloomberg. The table shows some of the other banks that have cleared the minimum leverage ratio to satisfy the Fed's concern.

Banks Leverage Ratio
State Street 4.2%
Goldman Sachs 4.1%
Wells Fargo 6.1%
Bank of America 5.4%
JP Morgan Chase 5%
Morgan Stanley 3.8%
Citigroup 5.5%
Bank of New York Mellon 5.5%
Ally Financial 7%
KeyCorp 6.8%
Capital One 6.3%
Huntington Bancshares 6.6%
Sun Trust Banks 7%
U.S. Bancorp 6%
Citizens Financial 6.8%
M&T Bank 7.5%
BB&T 7.9%
PNC Financial 6.7%
Fifth Third Bancorp 7.7%
Regions Financial 7.5%
Zions Bancorporation 8.1%
Comerica 8.5%
Discover Financial 10%
American Express 8.9%
Northern Trust 6.2%
CIT Group 11.9%

Fed Hikes Rate, House Cuts Dodd-Frank Reforms

While the Fed stress test showed that the banks could withstand a downturn, it has come at a time when the federal funds rate has been hiked by a quarter percentage point. Not only that, Fed officials stuck to their plans of another hike this year and issued forecasts that showed three more quarter point rate increases next year, which bodes well for banks. Higher interest rates boost bank profits by increasing the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities (read more: Fed Hikes Rate, Sets Asset Plan: 5 Top Gainers ).

Fed Chairwoman Janet Yellen had emphasized that the labor market looks quite healthy, justifying Fed's decision to raise rates for the second time this year and fourth time in 18 months. San Francisco Fed chief John Williams also said that the Fed needs to keep raising rates gradually as otherwise the economy runs the risk of overheating. New York Fed president William Dudley also said that the narrowing of credit spreads, stocks moving north and bond prices declining should encourage the Fed to continue its monetary tightening policies.

Lest we forget, the House of Representatives voted along party lines to erase a number of core financial regulations put in place after the 2008 financial crisis. The Republican bill, better known as the Financial Choice Act, would free up banks by giving more power to banking authorities and spurring lending activities (read more: 5 Bank Stocks to Buy as House Cuts Dodd-Frank Reforms ).

3 Biggest Gainers

Given the positive trends, we have selected three solid banks that have passed the first round of the stress test. These selected banks boast a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

KeyCorpKEY provides a range of retail and commercial banking, commercial leasing, investment management, consumer finance, and investment banking products and services to individual, corporate and institutional clients. The Zacks Consensus Estimate for its current year earnings increased 6.1% over the last 90 days.

The company's expected growth rate for the current year is 25.5%, more than the Banks - Major Regional industry's projected gain of 13.2%. KeyCorp has outperformed the broader industry in the last one-year period (+69.7% vs. +42%).

M&T Bank CorporationMTB provides retail and commercial banking services. It operates as the holding company for Manufacturers and Traders Trust Company and Wilmington Trust, National Association. The Zacks Consensus Estimate for its current year earnings advanced 5.7% over the last 90 days.

The company's expected growth rate for the current year is 14.1%, higher than the Banks - Major Regional industry's projected gain of 13.2%. M&T Bank has outperformed the broader industry in the last one year (+42.4% vs. +42%).

Banco Bilbao Vizcaya Argentaria SABBVA is a diversified financial company engaged in retail banking, wholesale banking, asset management and private banking. It also operates in the U.S. The Zacks Consensus Estimate for its current year earnings rose 11.5% over the last 90 days.

The company's expected growth rate for the current year is 23.6%, more than the Banks - Foreign industry's projected gain of 7.3%. Banco Bilbao Vizcaya Argentaria has outperformed the broader industry in the last one-year period (+50.9% vs. +32%).

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J P Morgan Chase & Co (JPM): Free Stock Analysis Report

M&T Bank Corporation (MTB): Free Stock Analysis Report

KeyCorp (KEY): Free Stock Analysis Report

Wells Fargo & Company (WFC): Free Stock Analysis Report

Citigroup Inc. (C): Free Stock Analysis Report

Bank of America Corporation (BAC): Free Stock Analysis Report

Banco Bilbao Viscaya Argentaria S.A. (BBVA): Free Stock Analysis Report

Regions Financial Corporation (RF): Free Stock Analysis Report

Discover Financial Services (DFS): Free Stock Analysis Report

Goldman Sachs Group, Inc. (The) (GS): Free Stock Analysis Report

CIT Group Inc (DEL) (CIT): 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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