Stress Test Results Set Stage for Bank ETF Rally

Late Thursday afternoon, the U.S. Treasury Department released the much-awaited results of the government's "stress tests" on 19 of the nation's largest banks. Among the big names instructed to raise capital: Bank of America (BAC), Wells Fargo (WFC), and GMAC. In all, the government's results indicate that 10 of the banks tested need to raise a total of $75 billion in capital.

• Bank of America: $33.9 billion
• Wells Fargo: $13.7 billion
• GMAC: $11.1 billion
• Citigroup (C): $5.5 billion
• Regions Financial Corp. (RF): $2.5 billion
• SunTrust Banks (STI): $2.2 billion
• KeyCorp (KEY): $1.8 billion
• Morgan Stanley (MS): $1.8 billion
• Fifth Third (FITB): $1.1 billion
• PNC Financial Services (PNC): $600 million

But the news out of Washington wasn't all bad - JP Morgan (JPM), American Express (AXP), and Goldman Sachs (GS), along with 6 others, were told that their capital levels are sufficient to withstand a deeper recession:

• JP Morgan Chase
• American Express
• Goldman Sachs
• Bank of New York Mellon (BK)
• MetLife (MET)
• Capital One (COF)
• State Street (STT)
• BB&T Corp. (BBT)
• U.S. Bancorp (USB)

Market Reaction

Although the amount of additional capital seems staggering, the market reaction to the announcement was generally positive, with many bank stocks, including several that were directed to raise additional capital, rising in after-hours trading on hopes that the worst of the financial crisis has passed. Uncertainty over the test results has hammered bank ETFs this week, with financial sector ETFs posting a median decline of 3.7% since Monday. While the stress tests focused on large U.S.-based banks, investor anxiety spread to other banking sectors. Regional bank ETFs, including IAT (-3.7%), RKH (-3.7%) and, KRE (-4.0%) have also posted big drops this week, as have international bank ETFs: IXG (-2.6%) and DRF (-3.5%).

Due to a lack of clarity regarding the specifics of the stress testing procedures, many investors were uncertain as to the recommendations the Treasury would issue. While the banking sector didn't emerge unscathed, the results were far better than the worst case scenario many investors feared. Bank ETFs should get a boost on Friday from after-hours gains from many financial institutions, but the stage may be set for a more extended recovery in the financial sector. With the stress tests in the books, the significant uncertainty that has weighed on bank stocks in recent weeks has been eliminated, and the results aren't as bad as many of us feared. If these institutions are able to quickly establish and effectively execute capital raises in the coming weeks, bank ETFs may be poised for an across-the-board rally.

Disclosure: No positions

Comments

[AndrewBaker:]

Yes, they will rally; and they did today, with me riding FAS up, thank you. But this is just trading for a profit, whilst in reality there is much more bad news to come out of the financials, so I won't be a long term owner. You bulls mark me down if you like: I can take that, but losing money I don't like, and you won't either when the drop comes.

May 08 12:45 PM