A Banking Holiday

The Federal Reserve conducts annual reviews of the largest financial institutions in the United States. The objective is to ensure banks are sufficiently capitalized to absorb losses during a hypothetical recession, safeguarding the ability to lend to households and businesses in times of crisis. Investors will see references to “CCAR” (Comprehensive Capital Analysis and Review) or “DFAST” (Dodd-Frank Act Stress Test).

The CCAR results were not a surprise and almost anticlimactic from our view. Banks are flush with capital and capital buffers have only improved since the last stress test in December 2020. The Federal Reserve Board’s report reads:

“Consistent with the two rounds of stress tests last year, the [CCAR] results show that large firms have sufficient capital levels to absorb losses during stressful conditions. This is due, in large part, to the substantial buildup of capital since the 2007–09 financial crisis.”¹

Banks have proven they can survive an economic downturn and are well positioned for economic turmoil in the future. The chart pictured below highlights the progress banks have made on capitalization ratios.² As a group, we believe financials are compelling given the combination of higher dividend payouts, stronger economic and lending activity, and eventually, larger interest rate spreads.

Progress Achieved

The positive remarks from the Fed represented a green light for banks to return more capital to shareholders. Due to the COVID-19 pandemic, banks were mandated to preserve capital and keep higher-than-normal liquidity ratios in the event financial conditions materially worsened.³ Unlike the Global Financial Crisis in 2008-2009, major financial institutions in the U.S. remained well capitalized throughout the 2020 pandemic-induced recession.

Buybacks and Dividends Grow

The results were not a surprise and some financial stocks sold off on the news. With the economy improving and strong economic growth outlooks for the second half of the year, investors began to price in this improvement as early as November 2020 when positive COVID-19 vaccine results were released.⁴ It is a positive to see companies quickly respond to this newfound flexibility in managing their balance sheets while returning capital to shareholders.

Many companies increased their dividends, with major U.S. banks recording a 48% increase from the prior quarter’s dividend.⁵ We view today’s dividend increases as a sign of confidence from management teams.⁶ There were also share buyback announcements, such as Morgan Stanley’s $12 billion authorization and Wells Fargo’s $18 billion authorization, to be completed by June 2022.⁷

Stephanie Link: CNBC TV Schedule

Sources

1. Federal Reserve Board,” Dodd-Frank Act Stress Test 2021: Supervisory Stress Test Results”, June 2021.
2. (Chart): Federal Reserve Board,” Dodd-Frank Act Stress Test 2021: Supervisory Stress Test Results”, June 2021. Note: The Federal Reserve’s evaluation of a firm’s common equity capital was initially measured using a tier 1 common capital ratio but now is evaluated using a common equity tier 1 capital ratio, which was introduced into the regulatory capital framework with the implementation of Basel III to replace Basel I. Not all of the 23 firms included in DFAST 2021 reported data for all periods since 2009
3. (Chart): Bloomberg.
4. (Chart): Bloomberg.
5. Bloomberg. Major Banks include Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, and Wells Fargo.
6. (Chart): Bloomberg. Dividend yield based on June 29, 2021 share price and annualized latest dividend announcement.
7. Morgan Stanley, “Morgan Stanley Announces 100% Increase of Its Quarterly Dividend from $0.35 to $0.70 Per Share and Authorization of the Repurchase of up to $12 Billion of Common Stock Over the Next 12 Months”, June 28, 2021. Wells Fargo, “Wells Fargo Issues Statement Regarding the Federal Reserve’s Stress Test Results”, June 28, 2021.

Disclosures

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.