Bank investors don't have to be so anxious about new stress tests

Though the Federal Reserve is giving lenders another tough exam, there are glimmers of optimism for banks' shares.

  • By Telis Demos,
  • The Wall Street Journal
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The Federal Reserve is now giving banks another, and in key ways even tougher, stress test. But this shouldn’t cause deep anxiety for investors.

In one of the Fed’s two new scenarios, unemployment peaks at a higher level, 12.5%, than in the February tests that determined capital levels. In the other, unemployment stays elevated longer, above 9% all the way through late 2023. That could make the test particularly unflattering for banks heavy in credit-card loans, whose loss projections are typically tied closely to jobless levels.

Importantly for investors, the Fed didn’t commit to what the results of this test will be used to do. It didn’t say how they would be used to recalibrate the stress-capital buffers that now determine banks’ minimum capital requirements. And with a decision on whether to extend a separate third-quarter restriction on dividend payments and buybacks to the fourth quarter due by the end of this month, it is also likely the Fed will make a decision on whether to extend the restrictions based on other criteria.

At first blush, it isn’t easy to see the central bank deciding to give big banks a green light for resuming share repurchases, especially since the new tests’ firm-specific results won’t be announced before December. The Fed this week also separately described the economic outlook as highly uncertain, suggesting a cautious posture.

However, the fact it didn’t immediately commit to an extension of the payout restriction or to recalibrating stress-capital buffers might unleash some bullish sentiment in banks—and a surprise decision to not extend the payout rule could be a big stock booster. JPMorgan Chase (JPM) Chief Financial Officer Jennifer Piepszak said earlier this week that “if we don’t have regulatory constraints, if we have excess capital…that I wouldn’t rule out share buybacks” in the fourth quarter. Yet the bank’s stock is still down on the week, suggesting the market considered that possibility unlikely.

There are some glimmers of optimism already peeking through the gloom, as shares of banks with larger excess capital buffers and more limited credit exposure, such as Morgan Stanley (MS), rose on Friday, even as bank stocks overall had a muted reaction to the Fed’s release.

Caution is still warranted, especially for banks such as Capital One (COF), whose dividend—already reduced in the third quarter—could in theory still be at risk from an extension of the payout rule. But stress isn’t always a killer.

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