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Big Banks Buoyed by Clean Bill of Health

28 March 2014 in Trading Ideas

Investors who have recently enjoyed a rally in the stocks of those banks deemed “Too Big to Fail,” were recently treated to a couple of data points that could suggest the upside isn’t over.

Late last week, the Wall Street Journal reported that the Federal Reserve’s annual test of the financial health of the nation’s largest banks showed they are strong enough to withstand a severe economic downturn.1

Specifically, the Fed said that 29 of the 30 largest institutions have enough capital to continue lending even when faced with a hypothetical jolt to the US economy lasting into 2015, including a severe drop in housing prices and a spike in unemployment. The annual tests, introduced after the financial crisis, are designed to ensure large banks can withstand severe losses during times of market turmoil.

According to the Journal, the test’s results could boost the desire by the banks – which have seen profits soar amid a better economy and severe cost-cutting – to return more of that income to shareholders. Next week, the Fed will decide to approve or deny individual banks’ plans for returning billions of dollars to shareholders through dividends or share buybacks.

The news may have served as a tailwind to the rally in the stocks of the country’s largest banks. The Too Big to Fail motif has gained 4.2% in the past month. The S&P 500 is flat during that same time period. Over the last 12 months, the motif has increased 31.8%; the S&P 500 has risen 21%.

 

As the Journal pointed out, the six biggest banks earned $76 billion in 2013, just $6 billion shy of their collective all time high. Meanwhile, some of the biggest institutions, including Bank of America and Morgan Stanley, haven’t raised dividend payouts since the financial crisis.

As if the perceived security of the nation’s largest banks needed even more help, this week saw the publication of a study by the Federal Reserve Bank of New York that found that the largest US banks have benefited from a significant funding advantage over their smaller peers, thanks in large part to the implicit assumption that they would be bailed out by the US government.2

While the finding may elicit a collective “Duh!,” from many investors, the Financial Times reminded that some earlier studies, including one by Goldman Sachs, had disputed the idea that a “TBTF” subsidy existed.

According to the New York Fed study, the biggest banks enjoyed an extra $60 million to $80 million of cost savings per average new bond sale over their smaller competitors, based on data taken from 1985 until 2009.

However, that finding also comes with a grey cloud attached – the FT noted that the study is part of a wide-ranging survey of large banks that will be closely read for hints about the future direction of banking regulation. While new rules are supposed to limit future bank bailouts, there is still a substantial movement among some authorities to break up the largest institutions.

In the meantime, one could forgive big-bank investors for feeling we’re as far away from 2009 as we could possibly be.


1Ryan Tracy, Stephanie Armour and Dan Fitzpatrick, “Fed ‘Stress Test’ Results” 29 of 30 Big Banks Could Weather Big Shock,” WSJ.com, March 21, 2014.

2Tracy Alloway and Tom Braithwaite, “NY Fed finds big banks enjoy taxpayer ‘subsidy,’ March 25, 2014.

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