Could Stress Tests Spark a Run for Financials?

Joel Anderson  |

This week, the Federal Reserve said that 15 of the 19 major banks subjected to stress tests passed with adequate capital reserves and helped push stocks in the financial sector higher. The stress testing, meant to simulate a severe economic downturn, showed that the 15 banks that passed had adequate capital reserves to survive the losses they would experience in sharply depressed economic conditions.

Shares of major US banks jumped across the board as a result of the news, including Morgan Stanley (MS), JP Morgan (JPM), Goldman Sachs (GS), and Bank of America (BAC). The most notable bank to fail the test was Citigroup (C).

“The scenarios were incredibly severe, and the banks fared extremely well,” said Michael Scanlon, one of the senior equity analysts with Manulife Asset Management.

But what does the success of the major banks in these stress tests really mean? Are naysayers claiming that the tests weren't strenuous enough in the right? Or do the solid results mean that the long ailing financial sector is finally on the mend?

Increased Dividends and Share Buybacks

One immediate result of the stress testing is that those banks that passed muster can now increase their dividends or engage in share buyback programs, actions previously blocked by the Fed until the results of the test could be seen. And the banks, which submitted dividend and share buyback plans to the Fed for approval, have now rewarded their shareholders.

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JP Morgan announced Tuesday that it would buy back $12 billion in stock and increase its dividend payment by $0.05 per share to $0.30 per share. Wells Fargo (WFC) announced that its dividend would more than double from $0.10 per share to $0.22 per share. Also getting in the action was US Bancorp (USB), which upped its dividend from $0.02 per share to $0.20 per share, and credit card issuer American Express (AXP), which increased its dividend from $0.07 per share to $0.195 per share.

One big winner was Bank of America, though, despite the decision not to increase its dividend. After failing previous stress tests and long seen as a trouble spot in the industry, Bank of America's passage of the test led to a major rally for its shares. The company has gained almost 10 percent over the last three days, good news for shareholders who have seen an over 80 percent drop over the last five years.

Naysayers Abound

While increased dividends have some investors licking their chops, there are also many experts who believe that the stress tests were not rigorous enough and that rushing into dividend payments could prove foolish.

“The Fed has essentially appeased critics and proclaimed the banks healthy without doing real due diligence,” said Anat R. Admati, a professor of finance and economics at Stanford. He added, “Why are we letting banks hand out dividend payments and encouraging risky behavior after they passed flimsy tests? It’s frankly dangerous, and the Fed should not allow it.”

Only time will tell if the banks have done enough to prepare themselves. However, with increased dividends and a new sense of stability among many, many investors may finally be ready to return to the financial sector.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

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