Key Points
In baseball, if a player smacks a hit 30% of the time they come to the plate, he or she is considered to be an exceptional talent. Given that, let’s give a hearty, sustained round of applause to America’s top lenders.
They deserve their hurrahs because each of the 32 banks and other financial institutions subjected to this year’s annual Federal Reserve (Fed) stress tests passed with the proverbial flying colors. Read on for which companies did the best under the Fed’s watchful eye, why the results are such good news for our economy, and how this will impact the shareholders of these companies.
Super stressed
The “stress” of the title is something of an understatement. The point of the Fed’s examination is to determine how effectively the nation’s most important banks (and, as we’ll see, bank-adjacent enterprises) would be able to cope with adverse economic scenarios.
There’s plenty of nightmare fuel in these hypothetical situations. This year, the Fed’s “severely adverse” scenario included a 39% collapse in commercial property values and, not to be outdone, a 30% dive in home prices. We sometimes fret about upticks in the unemployment rate measured in basis points, so how about a sudden, vicious spike in the indicator to 10%?
Wall Street isn’t spared, either. The Fed wanted to model — perish the thought! — a 58% drop in equity prices. If that wasn’t bad enough, they also put the banks through the paces of a severe widening of corporate bond spreads, and a fear index that climbed to 72%. The companies under the microscope also had to “endure” events such as a global deflationary scenario in which the U.S. dollar appreciated quickly and violently.
So, how did they do?
This ability to take such economic and financial hits is why we should be applauding so vigorously. The 32 companies tested not only “survived” these scenarios, they aced them. In technical terms, for those so inclined, every one stayed above its minimum common equity tier 1 capital requirements even in the most dire fictional circumstances.
Put in a more workmanlike way, per the Fed’s post-mortem press release on the tests, “large banks are well positioned to weather a severe recession and able to continue to lend to households and businesses.” All told, they have enough capital to absorb almost $708 billion in losses — a massive amount by any yardstick.
Under the most adverse combination of disasters, all lenders maintained sufficient capital to operate effectively. The winner among them was brokerage Charles Schwab (NYSE:SCHW), with a “stressed ratio” — equity capital divided by risk-weighted assets — over 32%. That’s especially impressive given that the range considered high and safe is 9% to 12%.
Three international lenders with significant presence in the U.S. trailed Schwab. These were UBS (NYSE:UBS) Americas (15.3%), Deutsche Bank (NYSE:DB) USA (14.4%), and Toronto-Dominion Bank’s (NYSE:TD) TD Group. As for our country’s Big Four, JPMorgan Chase (NYSE:JPM) clocked a 12.6% score, Citigroup’s (NYSE:C) was 10.3%, Bank of America (NYSE:BAC) scored 9.9%, and Wells Fargo (NYSE:WFC) brought up the rear with 9.2%.
Let’s look forward to some dividend raises
There are plenty of other metrics for folks who like to get granular with their banks (supplementary leverage ratio, anyone?). The test results are fairly comprehensive report, after all.
The takeaway, for me anyway, is this: despite macroeconomic hiccups and consumer/business worries about rising prices and potentially higher interest rates, the economy is motoring along, and these very healthy institutions are a key reason why. They’re lending capital, they’re providing credit, they’re building deposit bases, etc. In other words, doing everything good lenders do.
For investors, this will likely mean at least a bump in bank share prices over the next few days. More impactful (in my opinion), the Fed has, for now, frozen the “stress capital buffer” requirements that determine banks’ scope for capital allocation measures. Since many have grown their capital bases significantly over the past year, they have more greenbacks for robust dividend raises and new or expanded share buyback programs. In fact, just after the test results hit the headlines on Thursday, several of them announced double-digit dividend hikes.
In short, the banks did exceedingly well, and investors are about to reap some nice rewards from this. Batter up!
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Wells Fargo is an advertising partner of Motley Fool Money. JPMorgan Chase is an advertising partner of Motley Fool Money. Charles Schwab is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. Citigroup is an advertising partner of Motley Fool Money. Eric Volkman has positions in Charles Schwab. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool recommends Charles Schwab and recommends the following options: short June 2026 $97.50 calls on Charles Schwab. The Motley Fool has a disclosure policy.
