US banks set to pass Fed stress tests and boost dividends, say analysts

The biggest US lenders are expected to clear the Federal Reserve’s annual health check this year, showing they have ample capital that can be used to boost dividends, analysts said.

The results of the central bank’s so-called “stress tests” on Friday will determine how much cash lenders would need to hold to withstand a severe economic downturn. A less strenuous methodology this year means banks will probably perform better and return more money to investors via dividends and share buybacks, analysts said.

The yearly exercise, introduced following the 2007-2009 financial crisis, is integral to capital planning for the 22 large lenders being tested. It is also used by banks to determine how much in dividends can be given to shareholders.

“With the improved regulatory tone, hopes are high for some reduction in capital requirements… driven by less harsh stress tests,” said Vivek Juneja, an analyst at JPMorgan. Given banks’ high capital levels, he anticipated they would increase dividends by an average of about 3 per cent and boost share repurchases.

Tepid loan growth and a favorable regulatory environment will make banks more flexible as they manage capital and grow dividends. However, banks may stay cautious with capital.

“Despite an improved outlook for capital return, we continue to expect management teams to remain somewhat conservative nearer-term given ongoing tariff, economic uncertainty and the timing and the magnitude of regulatory reform,” analysts from Raymond James said in a report.

The scenarios for this year’s stress test are also expected to be less onerous versus last year.

“It includes a smaller decline in US real GDP, a smaller rise in unemployment rate, smaller declines in short/long-end rates and other improvements including less aggressive housing and equity pricing declines,” analysts at Jefferies wrote in a note.

In more good news for banks, the tests are expected to only become more manageable for banks going forward. In April, the Fed kicked off a sweeping effort to overhaul the tests, which would include, in future years, averaging results to reduce volatility and giving banks more visibility into how they are graded by the Fed.

“We view this as a major positive that will help banks and regulators better align on methodology between internal and Fed-run stress tests, with the output being less of a black box,” said Betsy Graseck, an analyst at Morgan Stanley. Changes in the process could begin as early as this year, she added.

Wall Street firms could also see some relief in their stress capital buffers, an additional layer of capital that the Fed requires large banks to hold on top of minimum capital requirements.

Goldman Sachs (GS.N) and Morgan Stanley (MS.N), which saw their buffers increased last year, are “poised for improvements this year,” the analysts at Jefferies wrote.

Meanwhile, Citibank (C.N) and M&T Bank (MTB.N) could see a slight uptick in their capital requirements, said analysts at Keefe, Bruyette & Woods.

Overall, analysts expect the regulatory environment for big banks to be more benign under the second administration of US President Donald Trump.

“Stress tests are likely to be less stressful in Trump 2.0,” analysts at Raymond James said.