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The Fed and Big Banks: Stress Test and Earnings Fest

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July 11, 2017
Bank Stress Tests and Earnings
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The Federal Reserve gave the nation’s largest banks a clean bill of health after the most recent stress tests—its annual review of their balance sheets—and the upshot has been a flurry of announcements from those banks including proposed dividend hikes and potential stock buybacks.

The next test for the big banks comes this week with the launch of earnings season. JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC), as well as a handful of regional banks, are set to open their books before the bell Friday. This assessment might be tougher for banks to pass after a challenging quarter, even with expectations that the financial sector overall will report year-over-year earnings growth of 6.8%.

“There are a lot of high hopes, but trading during the last quarter wasn’t great,” said JJ Kinahan, chief market strategist at TD Ameritrade. 

CCARs and Cognac?

For the first time in the seven years that the practice has been in place, all 34 of the big banks passed the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR). That means that the Fed is confident the banks are running close to minimum thresholds on capital and leverage—and that they can weather another recession.

“Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress,” according to the Federal Reserve.

The CCAR was the second leg of a two-part analysis the Fed undertook to insure that banks can withstand hypothetical turmoil like that which rocked the economy into a recession nearly 10 years ago. The tests are both quantitative and qualitative, and the recent CCAR finally gave banks the OK to distribute nearly 100% of their earnings.

“They were put in the penalty box for quite a few years, and their approaches to business have been very disciplined,” Kinahan said. “They were sitting on a lot of cash that they can now use to maximize their value to shareholders.”

Capital cushions are all fine and good, but it’s important to not confuse them with robust revenues and earnings. 

‘Doing Decently’

In late May, some bank executives broke the news at an industry conference that the robust trading that marked last year’s Q2—a period which included Brexit—didn’t repeat itself in 2017.

"We're doing decently in a reasonably challenging environment,” JPMorgan Chase Chief Financial Officer Marianne Lake said, according to the Wall Street Journal. “Performance is quite good but there's not a lot to trade around right now...there haven't been that many exciting events and we need a few more of them.”

She said that trading was off some 15% at the time from year-ago levels, and given the malaise that has marked the early summer markets, it’s not likely trading levels improved, according to analysts. There was little reaction, for example, to last week’s report about North Korea’s missile testing or to the minutes from the Federal Reserve’s June meeting, which typically ruffle investment feathers somewhere.

Kinahan said that investors should pay close attention to the forecasts bank executives serve up with their earnings. The aggressive dividend and buyback announcements might be a signal from the banks that they can push forward now that the Fed has loosened the reins. Couple that with the tighter Fed policies on the horizon: the prospect of at least one other step up in interest rates this year and the onset of balance sheet reductions, as well as an improving job market and strong consumer confidence, and their outlooks might be telling.

“We’ll see if the banks can continue to paint a positive picture going forward,” Kinahan said. 

Need help navigating the earnings parade route? This video shows you how, by using the Earnings Analysis* tab on the thinkorswim® platform.

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