It's official: Banks have made a truly amazing recovery from those dark days of the financial crisis, and the Fed's recent stress test is proof positive of this fact. The nation's biggest banks made a spectacular showing, with Bank of America (NYSE: BAC ) and Citigroup (NYSE: C ) in particular flaunting their bulked-up capital ratios.
This year, the Fed broke the up the Dodd-Frank Stress Test scenario into two parts, creating a full week of headline-grabbing banking news. After the excellent stress test results of March 7, we will soon find out which banks will be returning capital to investors when the Comprehensive Capital Analysis and Review results are revealed this Thursday.
Although the biggest banks have been getting most of the press, smaller banks received superb grades, as well. One of these is KeyCorp (NYSE: KEY ) , the Ohio-based money center bank that went into the stress test with one of the highest capital levels of all.
Should KeyCorp ask for a dividend increase or share buyback?
As Fool Analyst David Hanson recently noted, KeyCorp produced a notable improvement in its Tier 1 common "stressed" ratio, bumping that metric up to 8% from last year's 6.3%, placing it ahead of well-capitalized super-bank JPMorgan Chase (NYSE: JPM ) .
KeyCorp has strengthened its position since the financial crisis, paying back government bailout funds while bumping up capital. Earnings power -- a consideration of importance in the Fed's stress testing -- is also gaining momentum, as the bank takes advantage of a surge in commercial and industrial lending. In addition, the bank was able to increase its fourth-quarter 2012 net interest margin year over year by a robust 24 basis points. I think KeyCorp is in a good position to share some of its largesse with investors -- and I'm betting the Fed will feel the same way.
How much will KeyCorp share with investors?
After last year's test, KeyCorp wasted no time announcing its plan to repurchase up to $344 million worth of stock, as well as its intention to reevaluate its dividend payment. The bank raised its payout to $0.05 per share in May, up from its previous $0.03 per share.
Considering how swimmingly KeyCorp performed on the latest round of stress tests, I would expect a respectable increase in both of those metrics. Knowing that the Fed would frown on any increases over 30% of anticipated post-tax net income, however, the bank will doubtless keep its ambitions well below that level. Even with that limitation, I expect KeyCorp investors will feel a strong urge to cheer in the very near future.
Citigroup's triumph on this year's stress test has netted some especially good press lately. Yet the bank's balance sheet is still in need of more repair, and there's a considerable amount of uncertainty after a shocking management shakeup. Should investors be treading carefully, or jumping on an opportunity to buy? To help figure out whether Citigroup deserves a spot on your watchlist, I invite you to read our premium research report on the bank today. We'll fill you in on both reasons to buy and reasons to sell Citigroup, and what areas Citigroup investors need to watch going forward. Click here now for instant access to our best expert's take on Citigroup.