By: Jeff Pollock
June 29, 2017

In the aftermath of the financial crisis nearly a decade ago, the US Federal Reserve initiated the practice of administering an annualized “stress test” for each bank carrying $10 billion or more in assets. The objective was to ensure that the largest US financial institutions would have sufficient capital to continue its operations throughout times of economic and financial stress.

Dire economic scenarios are factored into the analysis, such as a 70% increase in the unemployment rate, a 3% GDP contraction, a 15% drop in home prices, and a 35% plunge in the stock market.

Shareholders of the US banks pay close attention to these results. The failure to pass means the institution cannot hike its dividend or approve a new share repurchase program.

Nine years and seven stress tests later, the results show that the US banks carry sufficient regulatory capital to withstand the scenarios contemplated by its central bank.

On Wednesday, the Federal Reserve approved the capital plans of the 34 banks subject to capital plan approval. This was the first time since the financial crisis that all plans received approval.

Five of the six large US banks subsequently issued a press release announcing its plans to return capital to shareholders.  JPMorgan, Morgan Stanley, Wells Fargo, Bank of America, and Citigroup announced dividend increases of 12%, 25%, 3%, 60%, and 100%, respectively. Furthermore, these named banks collectively intend to repurchase $63.5 billion of their own stock.

Despite the optimistic overtures that investors took to US financials subsequent to the US election, the sector has not only underperformed the broad S&P 500 index year-to-date, but valuations are worth consideration. On a Price-to-Book Value basis, which is simply the stock price relative to the assets minus its liabilities, several of the names in the table below are on our radar.

Bullish purchases into the sector following the US election were predicated on the expectation of higher interest rates, lower taxes, and deregulation. While the market is pricing in an additional rate hike in December, the appetite of Congress to lower taxes and deregulate the banks is less certain. The fallout of these events may present a better buying opportunity to accumulate stock in these companies than today.

 

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