These 2 Stress Tests Have Big Implications for Banks on Both Sides of the Atlantic

Two sets of results give clues about share dilution, dividends, and buybacks.

Mar 14, 2014 at 3:30PM

Stressed
Source: Flickr / PhilipC.

This March is a critical month for bank investors, as it brings us the results from long awaited stress tests both in the U.S. and overseas. Dividend, value, and growth investors all have something to gain -- or lose -- based on developments this month and I'll take a look at two key sets of stress tests.

Greek banks
For the past few years, Greece has been burdened by recession and record levels of unemployment. Both this economic slowdown and a subsequent drop in property values tore huge holes in bank balance sheets, requiring a 28 billion euro bailout last year. This recapitalization left the Greek government with majority stakes in all of Greece's four major banks.

The question for 2014 has been: How much more money will these four banks need? We now have the results -- and it's time to take a look.

As expected, Eurobank requires the most additional capital at almost 3 billion euros, an amount likely to be raised as the government seeks out new private investment for the bank. Greece's largest lender, National Bank of Greece (NYSE:NBG), requires 2.2 billion euros of additional capital. Greece's other two major lenders, Alpha Bank and Piraeus Bank, require capital increases of 262 million euros and 425 million euros, respectively.

National Bank of Greece, the most accessible Greek bank for U.S. investors, was quick to respond to the stress test results noting that it will not have to issue additional shares to raise capital. This removes the looming fear of share dilution and is a strong positive for the bank. Instead of issuing shares, NBG is targeting asset sales and internal improvements to bolster its capital levels.

U.S. banks
For those not involved in Greek banks, stress tests are still coming to a market near you. The Federal Reserve has set March 26 as the date for release of stress tests for the 30 largest American banks.

American banks are in better shape than their Greek counterparts, and recapitalization forced share dilution is not considered a major risk here. Instead, investors are looking out for indications on dividends and buybacks.

Closely watched here are Bank of America (NYSE:BAC) and Citigroup (NYSE:C). Both banks pay dividends on par with their own FDIC insured accounts. But positive stress test results could make these penny dividends a thing of the past. B of A and Citigroup are both eager to attract more dividend investors, and an increase into the 1%-2% yield range would help win some back.

Buybacks are also worth watching here. Both banks trade below book value. meaning share repurchases at these levels would help increase earnings per share and grow book value. Citigroup even trades below tangible book value, making repurchases at these levels even more accretive.

Stress filled month
Investors have already seen the results of the long awaited Greek bank stress tests and the overall positive outcome for National Bank of Greece. Now, U.S. investors await the results from the largest American banks. Investors should be on the lookout for dividends, buybacks, and capital ratios to see how they affect their investment positions.

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Alexander MacLennan has the following options: long, January 2015 $20 calls on Bank of America, long Bank of America Class B warrants, long January 2015 $40 calls on Citigroup, long January 2015 $45 calls on Citigroup, long January 2015 $50 calls on Citigroup, long January 2015 $7 calls on National Bank of Greece (ADR), and long December 2017 National Bank of Greece warrants. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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