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Big Banks Clear Dodd-Frank Stress Test: 5 Top Winners

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The Federal Reserve released the first round of its annual stress test results, mandated by the Dodd-Frank regulation. The findings showed that the 35 largest U.S. banks are well positioned to put more money in dividends, share buybacks and business investments. The banks have sufficient capital balance to withstand severe recession.

The results have been announced at a time when the Fed is forging ahead with rate hikes, reflecting an economy that is improving by the day. Banking on such positive developments, investing in sound bank stocks that have passed the litmus test will be judicious.

What Are the Dodd-Frank Act Stress Tests?

The Fed started testing banks in 2009, two years after the beginning of the financial crisis that resulted in a recession. The Fed had to test all U.S. bank holding companies with more than $50 billion in assets, per the Dodd-Frank law enacted by former president Obama in 2010.

But the threshold was raised to $100 billion last month by President Trump. These banks are subject to the Comprehensive Capital Analysis and Review (CCAR) that determines whether they can fund dividend payments and share buybacks amid economic turmoil.   

Banks Clear First Round of Fed’s Toughest Annual Stress Tests

All 35 banks that underwent the annual Dodd-Frank Act Stress Tests showed that they have enough capital buffers to weather an economic meltdown and recessions modelled by the Fed. These banks can withstand a situation where unemployment rate rises to 10%, an almost 6% increase from the current level; the stock market tanks by two-thirds and home prices plunge by 30%.

Banks’ capital scores remained comfortably above regulatory requirements in the first round of the stress tests, even though they had to bear losses due to higher credit card balances and one-time accounting challenges enacted by the recent congressional overhaul.

Fed Vice Chairman of Supervision Randal Quarles added that “despite a tough scenario and other factors that affected this year’s test, the capital levels of the firms after the hypothetical severe global recession are higher than the actual capital levels of large banks in the years leading up to the most recent recession”.

Banks Are Well Poised to Meet Financial Obligations

All 35 banks stayed above the 4.5% minimum capital ratio in a severely stressed situation. When it comes to assessing the ability of a bank to meets its financial obligations, State Street Corporation’s (STT - Free Report) 5.3% capital ratio turned out to be the lowest, per Fed. Credit Suisse Group AG (CS - Free Report) topped the list with 17.6%, followed by UBS Group AG (UBS - Free Report) and Banco Santander, S.A. (SAN - Free Report) at 16.4% and 15.2%, respectively.

The diagram shows all the 35 banks that have cleared the minimum capital ratio to satisfy the Fed’s concern.

 

Fed Rate Hikes Bode Well for Banks

While the stress test showed that the banks could withstand a downturn, it came at a time when the Fed lifted a key U.S. interest rate for the second time this year and signaled a slightly more aggressive plan to tighten monetary policy in the near term. Interest rates rose again as the U.S. economy gained strength and inflation crawled higher.

The Fed, as widely expected, raised its benchmark federal funds rate by a quarter percentage points to a range of 1.75% to 2% this month and predicted two additional rate hikes this year. This will take the count to four increases instead of three as planned earlier.

Needless to say, higher interest rates boost bank profits by increasing the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities.

5 Biggest Gainers

Given the positive trends, we have selected five solid banks that have passed the first round of the stress test. These selected banks carry a Zacks Rank #1 (Strong Buy) and 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

KeyCorp (KEY - Free Report) , as the holding company for KeyBank National Association, provides various retail and commercial banking services in the United States. The stock currently has a Zacks Rank #2. In the last 60 days, five earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings increased 0.6% in the same period. The company’s expected earnings growth rate for the current quarter is 23.5% compared with the Banks - Major Regional industry’s estimated rally of 9.3%.

M&T Bank Corporation (MTB - Free Report) offers deposit, lending, cash management, and other financial services to small businesses and professionals. The stock currently has a Zacks Rank #2. In the last 30 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings increased 0.1% in the same period. The company’s expected earnings growth rate for the current quarter is 32.4% compared with the Banks - Major Regional industry’s estimated rally of 9.3%.

Fifth Third Bancorp (FITB - Free Report) operates as a diversified financial services company in the United States. The stock currently has a Zacks Rank #1. In the last 60 days, 13 earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings increased 6.4% in the same period. The company’s expected earnings growth rate for the current quarter is 23.9% compared with the Banks - Major Regional industry’s estimated rally of 9.3%.

The Goldman Sachs Group, Inc. (GS - Free Report) operates as an investment banking, securities, and investment management company worldwide. The stock currently has a Zacks Rank #2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings increased 0.4% in the same period. The company’s expected earnings growth rate for the current quarter is 19.8% compared with the Financial - Investment Bank industry’s estimated rally of 12.3%.

The Toronto-Dominion Bank (TD - Free Report) provides various personal and commercial banking products and services in Canada and the United States. The stock currently has a Zacks Rank #2. In the last 60 days, four earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings increased 1.2% in the same period. The company’s expected earnings growth rate for the current quarter is 8.8%, in contrast to the Banks - Foreign industry’s projected decline of 48.2%

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