After the financial crisis in 2007-2009, U.S. banks have faced increased regulatory scrutiny. There were several pieces of regulation implanted to ensure that the economy never went through a period like that again.
The Volcker Rule was one such piece of regulation and it limited banks on different forms of investments. The limits applied to venture capital funds and different derivative trading. Another piece of legislation that was enacted was the Dodd-Frank Act. One part of this piece of legislation was for banks to undergo an annual stress test to make sure the financial system could withstand different crises.
Both the Volcker Rule and the Dodd-Frank Act have been in the news this week. The Volcker Rule entered the conversation as regulators rolled back some of the limitations on Thursday. The Dodd-Frank Act also came in to play on Thursday as the results of the stress tests were released.
Bank stocks rallied during the trading session on Thursday because of the news on the Volcker Rule. Unfortunately, they turned lower in after hours trading after the stress test results came out.
The Fed didn't release individual results from the stress test, but rather they released the overall results. Regulators asked the individual banks not to release any specific results until at least June 29. One of the possible actions the Fed can require of banks is to limit or suspend share buybacks and the same holds true for dividends.
The overall results were considered good, but the Fed took the action of requiring banks to suspend share buybacks. Many of the top banks had already announced that they would suspend buybacks. The bigger news was that the Fed instituted a dividend freeze. Dividend payments must remain at their current levels for the third quarter. The decisions were based more on the overall economy and the uncertainty regarding a recovery.
“While I expect banks will continue to manage their capital actions and liquidity risk prudently, and in support of the real economy, there is material uncertainty about the trajectory for the economic recovery,” Fed Vice Chair Randall Quarles said in a statement.
With the individual results set to be released next week, I ran the 34 banks through the Tickeron screener. Specifically, I was looking at the scorecard from the screener. It takes data from a number of different fundamental and technical analysis tools and ranks the stocks from “strong buy” to “strong sell”. Keep in mind, this is AI driven with no human bias or opinion taken in to account.
Of the 34 banks facing the stress test, none of them received “strong buy” or “buy” ratings. There are 16 that receive “hold” ratings, six “sell” ratings, and 12 “strong sell” ratings. The biggest problem appears to be in the fundamental analysis.
Only six of the 34 stocks have more positive fundamental readings than negative ones. There are six different categories and only six of these stocks have more positive marks than negative marks. There are several where the negative ratings and positive ratings are equal, but the majority show more negative ratings than positive ones.
Looking at the specific categories, only one stock has an above average Profit Vs. Risk rating. First Republic Bank (NYSE: FRC) with a rating of 29, barely in the positive column.
The SMR rating looks at sales growth, profit margin, and return on equity, and the only bank stock that ranks above average there is American Express (NYSE: AXP). Amex gets a score of 21 in the category.
In the Price Growth Rating category, the entire lot, all 34 stocks are in the neutral range.
What all of this data suggests to me is that the banking industry is set for a period where it will likely underperform the overall market. The limitations on dividends and buybacks will likely deter investors over the next three months. If investors aren't looking to buy the stocks in the group, we will likely see far more sellers than buyers.
There is still a lot of uncertainty about the economy and what shape the recovery may take. Some people think it will be L-shaped while others think it will be V-shaped or W-shaped. Regardless of which of these shapes ends up playing out, the banking industry looks like it will be handcuffed to some degree as the Fed looks to maintain some stability within the sector.