U.S. Banks Are More Attractive After Fed's Stress Test

by: Middat Yildiz


23 of the 35 banks participating in the stress test were U.S. banks.

10 of the 23 US banks increased their dividends at least more than 25%.

None of the 23 banks had dividend yield more than 3% before the stress test.

Eight of the US banks will have 3% or higher dividend yields after the stress test.

In order to maximize the value of the firm, companies execute several strategies, two of which are dividend payments and stock buybacks. Dividends tend to follow cash flow. Declaring dividends and increasing dividends act as a “signal” for the investors that company’s management is confident of its future earnings, cash flow and overall prospects. Increase in dividends therefore will lead to increased demand for firm's shares by investors attracted to higher yields, leading to a rise firm's share price.

Fed’s Stress Test

The stress test report is officially called “Comprehensive Capital Analysis and Review 2018: Assessment Framework and Results, June 2018”.

On June 28, 2018, the Federal Reserve (Fed) announced the results of the annual stress test for the U.S. banks. The Fed approved the proposed capital plans for the 32 of 35 biggest banks operating in the U.S.

Thirteen* of the 35 banks participating in the stress test are banks affiliated or owned by foreign banks or US holding companies of a foreign banks. The readers can access complete report here.

The Fed did not approve the capital plan of the U.S. holding company of Germany's Deutsche Bank, (DB), citing weaknesses in its assumptions for forecasting revenues and losses. Deutsche Bank has going through a reorganization and restructuring. The Fed conditionally approved State Street Corp’s (STI) plan on condition that it improves its analysis of hypothetical lending risks with other big banks. Even though the Fed approved the plans for Goldman Sachs (GS) and Morgan Stanley (MS), the condition on both firms was to keep their total dividend payouts and stock buybacks at current levels.

In this paper I separated 23 U.S. banks from the 12 subsidiaries of foreign banks. After the release of the stress test, all 23 U.S. banks announced their approved capital plans, i.e. share repurchases and dividend payouts. Their approved capital plans indicate a healthy U.S. banking industry in the next four quarters.

Highest Increase in Absolute Dividend Payments for the Next Four Quarters:

The following firms increased their dividends more than 30%, shown in Table -1. (Table_-_1.xlsx)

RF increased its dividend by 56%. It also has relatively low PBV ratio and respectable ROE. Even though C has negative ROE in the last 12 months, an increase of 41% in its dividend amount indicates a good signal by the management that its future prospects for earnings and cash flow. NTRS with the second highest Price-to-Book Value (PBV), and a ROE of 14.1% in the last 12 months, increased its dividend 31%. JPM with 3.05% dividend yield after the stress test after increasing its dividend by 43% appears to be undervalued with 1.54 PBV.

None of the 23 banks had dividend yield more than 3% before the stress test, but eight will have 3% of more dividend yields post “stress test.”

Eight of the 23 banks will have an annual dividend yield higher than 3%

Three percent yield is higher than the US ten-year treasury rate as of June 28, 2018, which was 2.84%.

Three percent dividend yield is also higher than the 2.1% of annual inflation in the US in 2016, and 2017. Inflation is expected to be around 2% in 2018. This is a significant factor investors do consider when making capital allocation decisions, whether their cash flow will be eaten up by the inflation or not.

Table -2 (Table_2.xlsx) shows none of the 23 banks had dividend yield greater than 3% before the stress test, but 8 of the 23 will have 3% or higher dividend yield in the next quarter based on the capital allocation announcements following the stress test. HBAN, KEY, WFC, BBT, RF, FITB, JPM, STI and USB are all attractive yield candidates for investments. RF, JPM, and KEY are also in Table -1 in a group, which increased their dividends more than 30%.

Share Buybacks May Prove to be a Bigger Impact on the Share Prices of US Banks:

Twenty-three US banks will buyback 9% of their outstanding shares in the next four quarters.

In terms of absolute dollars to be returned to the investors, Wells Fargo (WFC), Bank of America (BAC), JP Morgan (JPM) and Citigroup (C) will return a total $114 billion back to the investors.

$114 billion to be returned by the four banks represents 82% of the total ($138.5 billion) expected share repurchases and dividends announcements in the capital plan post stress test by the domestic US banks.

In terms of as percent of market cap, RF, C, WFC, FITB, and HBAN will return an amount equivalent to more than 10% of their market caps. For investors such large amount of share repurchase should provide a reasonable support for the share price. Table-3 (Table_3.xlsx) shows the total dollar amount of buybacks as percent of the market cap as of June 28, 2018.

Regions Financial Corp (RF) appears at the top of the list in terms of absolute percent increase in dividends, dividend yield and the total dollar amount to be returned to the investors as percent of market cap. RF therefore is my top long idea in this list.

Share repurchases announcements and dividend increases give a positive "signal" to the investors and provide information to the financial markets about companies’ cash flow and overall health. For US banks after the Fed Stress Test, both of these signals have been positive and the stocks should reflect the confidence of the management after the payout announcements.

Notes: Supporting Data can be found in Table_4.xlsx and Table-6-_Supporting_Data.xlsx.

* The non-U.S. firms participating in the stress test are: Barclays US, BBVA Compass Bancshares, BMO Financial, BNP Paribas USA, Credit Suisse Holdings (NYSE:USA), Deutsche Bank USA, HSBC North America Holdings, MUFG Americas Holdings, RBC USA, Santander Holdings USA, TD Group US and UBS Americas.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RF, BAC over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.