US Banks: Stress Test Results Look Favorable, With Goldman and Wells Fargo Performing Particularly Well

The Federal Reserve released the results of its annual stress test on Friday, June 27. With significantly stronger results compared with a year ago, the shares of the 22 tested institutions sold slightly higher in after-hours trading.

Why it matters: The test estimates the maximum capital drawdown banks are likely to experience during a severely adverse scenario, which in turn informs the level of stress capital buffer they are required to hold for the ensuing year.

• Lower capital requirements correspond with higher leverage and higher returns for banks, which may elect to return excess capital to shareholders, generally through share repurchases.
• After Friday’s test, we estimate that the banks in our coverage will see their stress capital buffers decline by about 40 basis points on average, provided that the Fed’s proposal to average stress test results over two consecutive years is implemented, or 65 basis points otherwise.

The bottom line: A less-punitive stress scenario and strong capitalization across our banking coverage means the average bank we cover could hold as much as 5% of its market capitalization in excess capital that could theoretically be returned to shareholders.

• Wide-moat Goldman Sachs and Wells Fargo were the biggest winners, with our estimates suggesting these banks will see their stress capital buffers fall by 1.5 and 1.2 percentage points, respectively, in October.
• However, our optimism is tempered by overvaluation. While returning capital to shareholders can improve a firm’s returns on equity regardless of price, we’d prefer that the banks don’t repurchase $1 worth of shares for $1.25, which is what they would effectively be doing at our market-cap-weighted fair value estimates.