June has become the most important month for bank stock investors. It's the month that the Federal Reserve releases the results from both the stress test and the follow-up comprehensive capital analysis and review, the latter of which dictates which of the nation's biggest banks will be allowed to increase their dividends and/or stock buybacks.
There are 33 banks that must submit to the process this year, including the nation's four biggest banks by assets: JPMorgan Chase (JPM -0.99%), Bank of America (BAC -0.37%), Wells Fargo (WFC -1.83%), and Citigroup (C -0.28%). Beyond this, a large swath of regional banks must also request permission from the Fed to return more capital to shareholders, including PNC Financial, BB&T, and SunTrust Banks, among others.
While most of the banks that have been stress tested in the past have been allowed to boost their dividends and/or share buybacks, there have been notable exceptions. Bank of America and Citigroup in particular have struggled over the years to satisfy regulators.
In 2014, for example, Bank of America had to resubmit its capital plan and suspend planned increases in capital distributions after incorrectly reporting data in the stress-testing process. Citigroup ran into problems the same year due to "deficiencies in its capital planning practices, including in some areas that had been previously identified by supervisors as requiring attention, but for which there was not sufficient improvement," the Fed said at the time.
And last year, JPMorgan Chase was found to have capital deficiencies under the Fed's severely adverse scenario. It was accordingly required to reduce the amount of capital that it had originally proposed returning to shareholders.
It's impossible to say for sure how the nation's biggest banks will perform on the 2016 test, given that the methodology behind the test changes every year. "In adjusting the scenarios for our yearly stress testing program, we strive to assess the resilience of the nation's largest banks in a variety of potential adverse environments," Federal Reserve Governor Daniel K. Tarullo said. "It is important that the tests not to be too predictable from year to year."
This aside, it isn't unreasonable for investors to assume that most of the banks will sail through the process. One of the reasons is that banks are generating higher earnings with each passing year. JPMorgan Chase earned $24.4 billion last year, the second best year of any bank in history. And Wells Fargo, despite being roughly a third smaller than JPMorgan, produced income of $21.6 billion. It's for this reason that I believe Wells Fargo investors in particular will likely see a dividend increase coming their way.
Even Bank of America and Citigroup have seen their fortunes improve. Last year was Bank of America's best year in nearly a decade, with $14.4 billion in net income. And Citigroup's bottom line more than doubled compared to 2014, going from $7.3 billion up to $17.2 billion.
In sum, because earnings feed capital, and assessing capital adequacy is the point of the stress test and CCAR processes, it stands to reason that these banks will be allowed to return more money to shareholders simply because they're earning more of it.
Editor's note: This article originally stated that the 2016 stress test and CCAR results are due in March, but that date has been postponed by the Federal Reserve to June according to a Jan. 28 press release. We regret the error.