Bank Stress Tests Have Additional Pressure Under Pandemic

When the U.S. and the world went through the financial crisis in 2007-2008, the public learned how fragile the global financial system really was. We learned a few new phrases as a result of the crisis, one of which was “Too Big to Fail”. We even got a movie by the same name.

Something else that came about as a result of the financial crisis was a number of new laws, one of which was the Dodd-Frank Act. Included in the act was an annual stress test of the largest banks in the country. The idea was to test whether or not the banks could withstand different crisis situations. At this point, 34 individual banks must undergo the stress test on an annual basis at the very least.

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The Fed is set to release the results of the stress test on Thursday afternoon, but it will only be the overall stress test that is released, not the individual scores. The Fed has asked the banks not to discuss individual results or to take any actions necessary from the test until June 29.

One of the actions that can be required from a bank that doesn’t meet the baseline standards is to suspend or eliminate share buybacks. They can also be required to eliminate or reduce their dividends. Several of the largest banks have already announced they were suspending share buybacks including JPMorgan Chase, Citigroup, Bank of America, and Goldman Sachs.

Wells Fargo is the third largest bank in the country in terms of assets and many analysts believe the troubled bank will have to cut its dividend after the stress test. S&P Ratings noted at least 12 other banks that are in danger of having to cut their dividend. Any dividend cuts will have a negative impact on the underlying stock.

S&P Ratings knows far more than I do about which banks are at risk of failing the stress tests, so I will take them at their word. What I did was run the 34 banks through Investor’s Business Daily to see how the stocks stand up in terms of their past earnings growth and other fundamental indicators. I use the EPS ratings and the SMR ratings as tools to get a quick glimpse of how different stocks compare to others.

For the 34 stocks facing the stress test, I looked at their SMR ratings first and I found there are five that receive “A” ratings, 23 get “B” ratings, and five get “C” ratings. One received an “N/A” in this category because the return on equity wasn’t calculable.

In the EPS ratings, I broke them down in to sets of 20 percentile groupings. There were 10 stocks in the top 20th percentile, 15 in the 60-79 range, eight in the 40-59 range, and one in the bottom 20th percentile.

Overall I would say that the banks are in pretty good shape, but all of these ratings are based on past results and barely got touched by the COVID-19 virus shutdowns that started in the first quarter. The next round of earnings results will start in a few weeks and those results will show a much greater impact from the virus.

In addition to running the stocks through IBD’s ratings system, I ran all 34 through another site’s rating system. I write for Tickeron.com and the site is an artificial intelligence-based platform. It takes data from a number of different fundamental and technical analysis tools and ranks the stocks from “strong buy” to “strong sell”. Keep in mind, this is AI driven with no human bias or opinion taken in to account.

Of the 34 banks facing the stress test, none of them received “strong buy” or “buy” ratings. There are 16 that receive “hold” ratings, six “sell” ratings, and 12 “strong sell” ratings. These totals are far less comforting than the fundamental ratings from IBD.

One of the biggest differences between IBD’s ratings and Tickeron’s ratings is the inclusion of technical analysis indicators. Because so many of the bank stocks have rallied sharply off the March lows, like most stocks, many of the technical indicators are flashing warning signs because the stocks are so overbought. This could be a big problem heading into earnings season and it could be setting some stocks up for big declines if they fail the stress test.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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