Although it wasn't a surprise given their recent earnings report and the economy's trajectory, all 27 of the biggest banks passed the Federal Reserve's stress test. As a result, many of them will be raising their dividends.
Fed Stress Test
As part of its efforts to increase confidence in the financial sector during the coronavirus pandemic, the Fed instituted higher capital requirements to ensure that there was no repeat of the financial crisis when many banks stopped lending money which exacerbated the crisis. However, these limits are being gradually lifted especially with the recent stress tests showing that banks have a capital buffer that is well-above the Fed's limits.
This development could be anticipated from earnings reports and in many ways, is already reflected in their stock prices. During the early parts of the crisis, banks posted losses as they set aside huge sums as reserves to protect against a spike in defaults. However, the spike in defaults never materialized due to the federal government's efforts and the economy performing better than expected. Now, these reserves are providing a tailwind to earnings.
In total, analysts are expecting that dividends for banks will increase by an average of 7% and share buybacks will increase by 6%. These moves will increase the attractiveness of shares and make the banks more profitable. Already, Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Wells Fargo (NYSE: WFC) announced that they would be hiking dividends.
Outlook
It's fair to say that this news wasn't exactly unexpected by investors given the massive gains in shares over the last few months. Shares were driven by these factors in addition to the steepening yield curve which makes banking more profitable.
However, it's also not a coincidence that the rally in banks fizzled out on this news as shares are more responsive to the flattening yield curve. It's quite ironic that the Fed's hawkish statement at the last FOMC meeting caused long-term rates to drop and short-term rates to spike.
In essence, the market believes the Fed's decision is bearish for longer-term growth and inflation expectations. Another factor is that getting another fiscal stimulus package through Washington seems less likely than a few months ago. These are the factors that will be more impactful on banks' stock prices in the near-term rather than the stress tests.