Despite the turmoil earlier this year, the US banking system remains strong, according to the results of the Federal Reserve’s annual stress test.
All 23 banks participating in this year’s test managed to stay above their minimum capital requirements despite suffering a theoretical loss of $541 billion in the hypothetical recession in this year’s test.
“Today’s results confirm that the banking system remains strong and resilient,” said Michael S. Barr, vice chairman for oversight, on Wednesday. “At the same time, this stress test is just one way to measure that strength. We should remain humble about how risk can arise and continue our work to ensure banks are resilient to a range of economic scenarios, market shocks and other stresses.”
Barr’s comment about humility hinted at the unexpected challenges looming in banking during the first half of the year. In recent months, three US banks – Silicon Valley Bank, Signature Bank and First Republic – all collapsed because their well-heeled customer bases immediately withdrew deposits over fears that the Fed’s rate hikes had lowered lenders’ interest rates. Ability to raise cash to pay customers.
Holding deposits has been a challenge for many banks as the Fed’s rapid rate hikes have forced savers to earn more interest on their nest egg. However, the banks most vulnerable to volatile deposits tend to be smaller regional banks that are not subject to the Fed’s annual test. The big banks subject to the tests, such as JPMorgan Chase (ticker: JPM) and Bank of America (BAC), actually saw their deposit base grow during this spring’s turmoil.
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Every year the Fed dreams up a bleak economic scenario and requires banks to demonstrate that they would be able to weather the hypothetically difficult times while continuing to lend. In this year’s test, banks were asked to prove their ability to withstand a “severe global recession” that resulted in a 10% unemployment rate and corresponding commercial and residential property values falling by 40% and 38% respectively. In such a scenario, banks would incur total losses of $541 billion, including $100 billion in losses on commercial and residential mortgages and $120 billion in losses on credit cards.
This year’s test also included a test of banks’ trading books amid higher interest rates and inflationary pressures. The Fed noted that the largest banks were “resilient” in the face of these shocks.
The results of this year’s test should give Wall Street some comfort, even if the more vulnerable smaller banks are not included. Passing the test paves the way for banks to update their buyback and dividend plans. Banks are allowed to disclose their intentions on Friday, but many expect lenders to exercise restraint amid recent headwinds, analyst reports said ahead of Wednesday’s release.
While payout ratios — comprised of dividends and buybacks — at the largest banks are expected to rise 13 percentage points year over year to 72%, according to analysts at Keefe, Bruyette & Woods, the increase is more likely due to lower expected earnings than a sharp rise in dividends and buybacks. Similarly, analysts at JP Morgan Securities expect dividends for banks in their coverage universe to rise by an average of 4%, while some banks may forego buybacks altogether as they await greater clarity on economic and regulatory conditions.
Wells Fargo is one of the banks JP Morgan looked at
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(WFC) could see the highest dividend increase — up 23% sequentially — as the bank hikes its dividend again after cutting it during the pandemic. That would give Wells Fargo a 3.6% dividend yield versus 3%.
Truist (TFC) and Citigroup (C) are expected to leave their dividends unchanged. Truist’s payout ratio has increased this year and Citigroup has a lower valuation, which would make share buybacks more tempting than dividends.
Overall, the prospects for large payouts this year are much more muted than in previous years, reflecting a challenging economic environment as well as calls for tight regulation and capital restraints on banks with assets of $100 billion or more after bank failures earlier this year.
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“We expect June 30 to be less of a deal than previous years. “While we expect most of the banks in our coverage to increase their dividends at some point in 4Q23-3Q24, share buybacks are likely to be relatively muted for many in the near term,” Barclay’s analyst Jason Goldberg wrote in a recent report note.
Expect bank investors to feel subdued, too.
Write to Carleton English at [email protected]