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Big Bank Stress Tests: Not So Stressful

15 March 2013 in Trading Ideas

This just in: The market is off to a very good start in 2013.

And rarely does such an accomplishment come without the contribution of the financial sector, which, in this day and age, is seen by many as America’s prime industry.

But financials have been extra-special so far this year. The Too Big To Fail motif, for example, is up 8.6% year-to-date, and 22% in the past 12 months. The S&P 500 has risen 6.5% in 2013, and is up 13.9% in the past 12 months.

Of course, in a timeframe where stocks have been on an incredible tear – the S&P 500 has gained about 15% in the past four months — one could point out that, well, everything is up. (OK, not Apple (AAPL)).

It’s against this potentially manic backdrop that those people investing in bank stocks may welcome some hint at confirmation that a little more substance could justify the runup.

Enter the news last week that the Federal Reserve’s survey of the 18 largest US banks, its so-called stress test, found that only one firm was not able to withstand a severe recession (Ally Financial (ALLY), for those scoring at home).1

That’s not to imply that the country’s mega-banks would be unaffected. The Fed found that a deep recession with peak unemployment of 12.1% would result in losses of $462 billion over a nine-quarter period, according to Bloomberg.

But for the Fed, and the country as a whole, there’s a difference between huge losses and the potential for another multi-bank bailout. As a result, the Fed and other government regulators have been compelling banks to retain more earnings to buffer catastrophic losses.

Longer term, many investors are hoping that a stamp of approval on the capital ratio of big banks could lead to increased dividends or big buyback plans – both of which could be catalysts to help drive the shares of bank stocks higher.

Beneath this apparent silver lining, however, is the possibility that the Fed’s test is underestimating the impact of a severe recession. That was the charge by one banking analyst, who told the New York Times, he thought the projected losses on loans were too low for the severity of the hypothetical crisis.2

For investors enjoying the recent runup in bank stocks, such concerns haven’t yet proven powerful enough to incite a selloff.

1Craig Torres & Joshua Zumbrun, “Fed Tests Show 17 of 18 Banks Weathering Severe Slump,” Bloomberg News, March 7, 2013, http://www.bloomberg.com/news/2013-03-07/fed-stress-tests-show-17-of-18-banks-weathering-severe-recession.html, (accessed March 12, 2013).
2Peter Eavis and Ben Protess, “Banks Pass Fed’s Tests; Critics Say it Was Easy,” The New York Times, March 8, 2013.

Tags: Banking