On Wednesday, the Federal Reserve announced the results of the second round of stress tests, and 29 of the 31 banks who were tested received approval for the capital plans they submitted. However, in arguably the biggest surprise of the stress tests, Bank of America (NYSE:BAC) received "conditional approval" for its capital plan. What exactly does this mean, and should shareholders be worried?
What is conditional approval, and why did Bank of America get it?
The whole point of evaluating the banks' capital plans is to assess whether or not they can increase the amount of capital they return to shareholders while maintaining a strong enough financial position to survive a hypothetical recession.
Of the 31 banks tested, two (Deutsche Bank (NYSE:DB) and Santander (NYSE:SAN)) were rejected, and Bank of America was given "conditional approval". It's unclear at this point exactly why this was done, as the results simply said the bank had "deficiencies" in predicting how well it would perform in an economic downturn as well as "weaknesses" in the bank's internal controls.
And while no specifics were given, the Fed didn't reject the bank's plan. It simply asked Bank of America to correct the situation and submit a revised plan by the end of September.
After the announcement of conditional approval was made, the bank announced a new $4 billion buyback program, but will not increase its dividend this year.
Here we go again, right?
This news may be more unsettling to shareholders than it needs to be, simply because it conjures up memories of Bank of America's stress test drama last year.
In April 2014, Bank of America announced that its capital plan failed to include $4 billion in losses that it had accumulated over the previous few years. As a result, the bank was forced to delay its plans to boost its dividend to $0.05 per share and implement a new buyback program.
The bank eventually resubmitted its plan, which it had reviewed by a third-party accounting firm, and was able to increase its dividend after all. It turns out the changes barely moved the bank's capital ratios, but the "$4 billion math error" still left a bad taste in investors' mouths, and could have possibly contributed to the Fed's issues with the bank's internal controls.
Shareholders shouldn't worry
Immediately after the announcement, shares of Bank of America fell in the after-hours trading session. However, by the following day, once the market had a chance to process the news, shares had recovered from the losses. So, it seems that the market isn't terribly worried about the bank's ability to comply with the Fed's request -- and it shouldn't be.
The Fed isn't saying that Bank of America will have trouble surviving another recession or doesn't have adequate capital levels to boost its returns to shareholders. It just wants Bank of America to address some internal issues before it can give the bank its blessing.
Admittedly, Bank of America still has a long way to go before it begins to resemble a safe, long-term investment. However, even skeptics must admit that the bank is in much better shape now than it was in 2009 when the Fed started to conduct stress tests. For shareholders, the fact that the Fed has said the bank is adequately capitalized to weather a pretty intense economic storm should help boost their confidence a little in regards to the safety of their investment.