The Federal Reserve released the results of the 19-bank stress test last week.
Overall, the market viewed the results quite favorably, helping to extend the run that banks of been on in early 2012. In an extreme case, Bank of America is up about 20% in a week and more than 70% year to date.
The stress test subjected bank capital ratios to a hypothetical scenario akin to our recent financial crisis. Unlike the 2009 test, the levers pulled were pretty harsh:
- Peak unemployment of 13%.
- An approximate halving of the stock market (the Dow would go below 6,000!).
- A 21% drop in housing prices.
The result of such a scenario would be that the 19 big bank holding companies would lose $534 billion by the end of 2013.
Although critics rightly point out that a rising interest-rate scenario isn't addressed, the fact that the scenario could be as harsh as it was is a good sign for the strength of banking. Investors should take the stress test for what it is -- another data point.
When the results were released, four banks had to go back with a revised capital plan, but only one bank holding company truly failed the test -- Ally Financial. It's the only one whose minimum Tier 1 common capital fell below 5% in the stress scenario (assuming no capital actions -- no dividend increases, share buybacks, or capital raises) that stretches to the end of 2013.
Minimum Tier 1 Common Capital Ratio*
|Bank of New York Mellon||13.3%|
|Capital One Financial||7.2%|
|PNC Financial Services||6.6%|
|Bank of America||5.7%|
Source: Federal Reserve.
*Under the stress test scenario assuming no capital actions.
Because the bank holding companies are a diverse lot these days, we should note that the first true banks on the list are Fifth Third and US Bancorp, at 7.7%, followed by BB&T at 7.3%. State Street and Bank of New York Mellon make their money on the trust side, and American Express is more credit card purveyor than retail bank.
On the low end, the first true banks are investment bank Morgan Stanley and regional bank SunTrust.
On a relative basis, of course it's better to be closer to the top than to the bottom, but as I said before, use these results as just one data point that helps determine the strength of the banks. And this particular data point relies heavily on the projections of the banks themselves and the Fed over one scenario.
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Anand Chokkavelu owns shares of Bank of America, Wells Fargo, Fifth Third, PNC Financial Services Group, JPMorgan Chase, Citigroup, and KeyCorp, but he holds no other position in any company mentioned. He also owns long-dated options on Bank of America and warrants on Citigroup, Wells Fargo, and JPMorgan Chase. The Motley Fool owns shares of KeyCorp, JPMorgan Chase, Citigroup, Bank of America, PNC Financial Services Group, Fifth Third Bancorp, and Wells Fargo and has created a covered strangle position in Wells Fargo. Motley Fool newsletter serviceshave recommended buying shares of Wells Fargo and Goldman Sachs and creating a write covered strangle position in American Express. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.