Today after the market closed, the Federal Reserve announced the results of its latest round of stress tests (link opens PDF), which are designed to gauge how well the nation's largest banks would hold up under three hypothetical and increasingly severe economic scenarios.
While there are multiple components to the test, one of the most important looks to the impact that the "severely adverse" scenario will have on the Tier 1 common capital ratios of the nation's 18 largest bank holding companies. The objective is to maintain a level above 5%.
Bank Holding Company
Pre-Test Tier 1 Common Capital Ratio
Post-Test Tier 1 Common Capital Ratio
Bank of America
Bank of New York Mellon
Fifth Third Bancorp
Source: Federal Reserve.
As you can see, all but one of the institutions maintained Tier 1 common capital ratios above the requisite 5% benchmark. The lone exception is Ally Financial, which saw its capital base erode by 79% under the severely adverse scenario, from 7.3%, down to 1.5%.
Conversely, BB&T and the custodial Bank of New York Mellon experienced the least capital erosion, watching their capital levels fall by only 0.1 percentage points.
Of the four traditional too-big-to-fail banks -- JPMorgan, B of A, Citigroup, and Wells Fargo -- Citigroup came out looking the best in terms of Tier 1 common capital, with a post-test ratio of 8.3%. It should be noted, though, that it started at a significantly higher point than the others, going into the test with a ratio of 12.7%. JPMorgan, on the other hand, saw its ratio fall to 6.3%, most likely as a consequence of its significant investment banking operations and global footprint -- and the same happened to Goldman Sachs.
The bank that investors have probably watched the closest, B of A, saw its hard-fought capital base fall by 40%, down to 6.8%. This is notably much better than it did last year, when its post-stress tested capital was an estimated 5.7%.
Looking forward, the big question is whether these results will be good enough to convince the Fed that dividend hikes are in order. Assuming the individual banks don't release this news sooner, investors should learn this next Thursday, giving the tested institutions time to digest the above results and decide whether they'd like to resubmit their capital allocation requests.
In the past, both Citigroup and Bank of America have had such requests denied; however, few analysts, myself included, believe that will happen again this time. Earlier today, the veteran banking analyst Richard Bove predicted that all of the banks are "going to show increases in dividends and the percentage increases could be very big in some cases."
With respect to Citigroup and B of A specifically, Bove went on to note that: "What you're looking for in names like Citigroup and Bank of America is some increase in dividends to certify that the Federal Reserve is not unhappy with them." As I discussed here, noted bank analysts Meredith Whitney and Tom Brown had expressed similar sentiments earlier in the year.
Suffice it to say, the proof is in the pudding.
While it's still too early to gauge the market's reaction to the stress test results, many bank shares are trending lower in after-hours trading. Morgan Stanley is down by 1.5%, Goldman Sachs by .08%, JPMorgan by 0.85%, and Wells Fargo by .033%. Heading up, alternatively, are shares of Citigroup, BB&T, and The Bank of New York Mellon. And B of A and US Bancorp are both even since the close.
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The article Only 1 Bank Failed the Stress Test originally appeared on Fool.com.
John Maxfield owns shares of Bank of America. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo. 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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