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Will 2020 Stress Test Allow Banks to Sustain Investor Rewards?
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The annual stress test results are due later this week. Everyone is keen to know how coronavirus-induced mayhem and subsequent economic slowdown are going to impact major banks’ capital deployment plans in the next four quarters.
So now, the big question is what will be the outcome of this annual exercise, which had started following the 2008 financial crisis?
Before we delve deeper into the current situation, we must know that the present backdrop has nothing to do with banks’ liquidity issues (unlike the 2008 crisis). Before the coronavirus pandemic outbreak in March, banks had sufficient liquidity and strong balance sheet position. Also, the U.S. economy was going strong before being pushed to a sudden halt because of the outbreak.
Last year, banks earned record profits despite the Federal Reserve cutting rates thrice. Improved profitability was mainly driven by solid economic strength and decent loan demand, along with banks’ ability to diversify revenues.
Further, per the Fed data, banks witnessed a record $2 trillion surge in deposit balances since February 2020-end to reach $15.3 trillion as of May 31, 2020. Thus, we can see that there is no major liquidity concern for the banks.
Nonetheless, with the virus continuing to wreak havoc across the globe and slowing down economic activities, banks will have to keep building reserves for loans that might get delinquent. During first-quarter 2020, banks recorded billions of dollars worth of loan loss provisions, with a similar or even larger amount expected to be added this quarter.
The central bank projects U.S. GDP to contract 6.5% this year, with the unemployment rate being 9.3%. Thus, the economy is not going to be a big supporting factor for banks’ financials.
This year’s stress test scenarios, announced in February, were already considered too stringent. The severely adverse scenario (with the unemployment rate being less severe than the recent drop in employment and output in the second quarter) will now act as the starting point of the new “sensitivity analysis.” This was revealed by the Federal Reserve’s vice chair Randal Quarles while giving a speech on Friday.
This “sensitivity analysis” will take into consideration three recovery scenarios — ‘V-shaped’, ‘U-shaped’ and ‘W-shaped’ — to decide banks’ capital adequacy and payouts. He said, “We simply would not have been doing our jobs if we had just run the test using a scenario framed before the economy began to deteriorate in March.”
For banks that have already suspended buybacks, chances of resumption seems less effective next quarter. Coming to dividend payouts, we can simply forget that there is any opportunity of a hike this time.
Moreover, in case banks are required to slash/suspend dividends, the resumption will largely depend on economic recovery. Quarles said, “We don’t have to make a decision now that is effective for a year.” Hence, if the economy recovers, there is a high chance that banks will start paying dividends at least at the current rate (albeit after getting the Fed’s approval).
But to know what’s actually going to happen, we will have to wait until Thursday.
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Will 2020 Stress Test Allow Banks to Sustain Investor Rewards?
The annual stress test results are due later this week. Everyone is keen to know how coronavirus-induced mayhem and subsequent economic slowdown are going to impact major banks’ capital deployment plans in the next four quarters.
Banks have already suspended share repurchases till the end of this quarter. Also, big banks including JPMorgan (JPM - Free Report) , Bank of America (BAC - Free Report) , Citigroup (C - Free Report) and Goldman Sachs (GS - Free Report) are under pressure to curtail/suspend dividend payments.
So now, the big question is what will be the outcome of this annual exercise, which had started following the 2008 financial crisis?
Before we delve deeper into the current situation, we must know that the present backdrop has nothing to do with banks’ liquidity issues (unlike the 2008 crisis). Before the coronavirus pandemic outbreak in March, banks had sufficient liquidity and strong balance sheet position. Also, the U.S. economy was going strong before being pushed to a sudden halt because of the outbreak.
Last year, banks earned record profits despite the Federal Reserve cutting rates thrice. Improved profitability was mainly driven by solid economic strength and decent loan demand, along with banks’ ability to diversify revenues.
Further, per the Fed data, banks witnessed a record $2 trillion surge in deposit balances since February 2020-end to reach $15.3 trillion as of May 31, 2020. Thus, we can see that there is no major liquidity concern for the banks.
Nonetheless, with the virus continuing to wreak havoc across the globe and slowing down economic activities, banks will have to keep building reserves for loans that might get delinquent. During first-quarter 2020, banks recorded billions of dollars worth of loan loss provisions, with a similar or even larger amount expected to be added this quarter.
The central bank projects U.S. GDP to contract 6.5% this year, with the unemployment rate being 9.3%. Thus, the economy is not going to be a big supporting factor for banks’ financials.
This year’s stress test scenarios, announced in February, were already considered too stringent. The severely adverse scenario (with the unemployment rate being less severe than the recent drop in employment and output in the second quarter) will now act as the starting point of the new “sensitivity analysis.” This was revealed by the Federal Reserve’s vice chair Randal Quarles while giving a speech on Friday.
This “sensitivity analysis” will take into consideration three recovery scenarios — ‘V-shaped’, ‘U-shaped’ and ‘W-shaped’ — to decide banks’ capital adequacy and payouts. He said, “We simply would not have been doing our jobs if we had just run the test using a scenario framed before the economy began to deteriorate in March.”
For banks that have already suspended buybacks, chances of resumption seems less effective next quarter. Coming to dividend payouts, we can simply forget that there is any opportunity of a hike this time.
Moreover, in case banks are required to slash/suspend dividends, the resumption will largely depend on economic recovery. Quarles said, “We don’t have to make a decision now that is effective for a year.” Hence, if the economy recovers, there is a high chance that banks will start paying dividends at least at the current rate (albeit after getting the Fed’s approval).
But to know what’s actually going to happen, we will have to wait until Thursday.
Zacks Top 10 Stocks for 2020
In addition to the stocks discussed above, would you like to know about our 10 finest buy-and-hold tickers for the entirety of 2020?
Last year's 2019 Zacks Top 10 Stocks portfolio returned gains as high as +102.7%. Now a brand-new portfolio has been handpicked from over 4,000 companies covered by the Zacks Rank. Don’t miss your chance to get in on these long-term buys.
Access Zacks Top 10 Stocks for 2020 today >>