Banks Stress Tested: Most Pass

Stocks Rebound Modestly

After a terrible week and a bad run for the bank stocks, the market finally rallied on Thursday. I expected this rally since the CNN Fear and Greed index showed the market was oversold. Interestingly, the Dow’s decision to replace GE with Walgreens was a big mistake in the near term. GE stock is up 8.47% since Monday’s close and Walgreens was down 9.9% on Thursday, hurting the Dow’s performance. The Dow still managed to eke out a 0.41% gain. The S&P 500 was up 0.62% and the Nasdaq was up 0.79%.

Stress Tested Banks Rally

The bank stocks did well as the financial sector in the S&P 500 was up 0.86%. On Thursday, the Fed released its stress tests of the banks which tells them whether they can increase their capital returns because they have solid enough balance sheets. Morgan Stanley and Goldman Sachs had a temporary issue which hurt their ability to return cash to shareholders because their capital ratios fell as a result of the tax cuts. Some of the banks needed to pay extra taxes in preparation for the new tax code at the end of last year.

These two banks fell beneath the minimum required ratios for capital levels called tier 1 leverage and supplementary leverage under a scenario of financial distress. The regulators gave them conditional non-objections to their capital plans. Goldman is going to pay out $6.3 billion starting in Q3; it is raising its dividend 5 cents to 85 cents. Morgan Stanley is giving out $6.8 billion which is the same as last year. It’s raising the dividend from 25 cents to 30 cents. Morgan Stanley was up 2.33% and Goldman Sachs was up 1.46% on the day.

The stress tests results were released after the close, so we need to look at the after hours action to see how they effected the stocks. Both Morgan Stanley and Goldman Sachs were flat after hours. The XLF ETF was up about 0.71% after hours, meaning those two firms underperformed. The bank sector should be up on Friday. State Street was given a conditional non-objection as well; it was asked to improve its management of counter-party risk.

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