Buoyed by a rising-rate environment, regional banks had little trouble passing the Dodd-Frank Act stress tests.
The strong results should enable the sector to deliver, as expected, shareholder returns in excess of 100% of earnings.
In research notes recapping the June 22 results, several analysts tabbed Regions Financial Corp. as delivering one of the highest payout ratios in next week's Comprehensive Capital Analysis and Review process. Analysts for FBR & Co. estimate the bank's combined payout ratio — a measure of share repurchases and dividends relative to income — will check in at 155% and that the consensus among analysts is roughly 128%. Kevin Barker, an analyst with Piper Jaffray & Co., predicts that regulators will approve a payout ratio in the range of 130% to 150% for the bank.
"I think it's just a matter of how aggressive they want to be," Barker said in an interview, adding that banks took notice of M&T Bank Corp.'s successfully aggressive distributions in last year's exercise. With strong results in the June 22 announcement, Barker said many of the regional banks could hit payout ratios of up to 300% before breaching the minimum ratios required by the stress tests, but that the Federal Reserve would be unlikely to allow such high payouts.
Despite results that analysts thought confirmed the likelihood of a strong payout ratio, Regions' stock dipped 1.3% by midafternoon June 23. Citizens Financial Group Inc.'s stock took an even larger hit, dropping roughly 2.0%. Barker said the market was overreacting to the bank's lower minimum ratio, which was driven by a change in the Federal Reserve's model for determining pre-provision net revenue, or PPNR.
"Citizens has lower profit margins and lower fee income relative to peers, so the PPNR estimates by the Fed came in relatively worse," Barker said.
The difference in the Fed's model contributed to Citizens reporting one of the larger gaps between the company's internally run results and the regulator's results, with a difference of 2.3% in the bank's common equity Tier 1 capital ratio. Still, the bank's ratios were high enough that Barker felt comfortable projecting a 103% payout ratio. Other equity research firms, Compass Point Research & Trading and RBC Capital Markets, expected an increase for the bank relative to last year's 80% mark but still below 100%.
Compass Point's analysts pointed to Citizens' higher loss rates compared to last year's exercise in commercial and industrial loans, commercial real estate loans and other consumer loans. But Citizens' loss rates were far from the highest among the stress test banks. From a loss rate perspective, Goldman Sachs Group Inc. stood out with C&I losses at 11.1% and first-lien mortgages at an eye-popping 52.3%.
From an overall total loan loss perspective, Capital One Financial Corp. and Discover Financial Services stood out as the only two banks with double-digit loss rates at 12.2% and 13.0%, respectively, driven by the banks' large credit card exposure. The stock market took the numbers in stride as the banks' shares were down only slightly around mid-afternoon. But Discover might have a bit more to worry about. Analysts for Instinet LLC wrote in a June 23 note that Discover's distributions might need to be reconsidered since payouts might push the bank below the required minimum ratios for Tier 1 capital and total capital.
"[Discover] appears more at risk of having to utilize the mulligan" or lower payouts, the analysts wrote.
The stock market also appeared to react coolly to Morgan Stanley's results, with its stock down 1.8% around mid-afternoon. Morgan Stanley was one of the large banks subjected to the supplementary leverage ratio for the first time and its low-point ratio of 3.8% came closest to breaching the regulatory requirement of 3.0%. Goldman Sachs' was next-closest at 4.1%. RBC Capital Markets' Gerard Cassidy noted that the two Wall Street banks reported the largest declines in their common equity Tier 1 ratios. Morgan Stanley's dropped 8.4% from the start of the stress test to its low point and Goldman Sachs fell 6.1%. The median decline was 2.8%.
Analysts also highlighted Huntington Bancshares Inc. as having the lowest expected payout ratio. Cassidy projects a payout ratio of 50%, and Compass Point's analysts set their prediction at 62% and reported market expectations were for 60%. Still, the bank reported stronger results than last year's test, allowing for a relatively higher payout.
To view the Federal Reserve-run 2017 Dodd-Frank Act stress test results click here.
Click here to access a template with the Federal Reserve-run 2017 Dodd-Frank Act stress test results and supplemental data for the participating bank holding companies.
Click here to access a template of the Federal Reserve-run and the company-run 2017 Dodd-Frank Act stress-test results for the participating bank holding companies.