Last week, Bank of America (NYSE:BAC) got a passing grade – and a footnote – on the Federal Reserve’s stress test.
The passing grade means that it can continue to pay a dividend and to buy back shares under its ongoing $4 billion repurchase plan. The footnote? Well, it seems the Fed isn’t done testing Bank of America. It noted that while the bank has made strong progress, it “must continue to make steady, demonstrable progress” before the next stress test begins in the spring.
That caution might be dismissed were it not for the fact that the Fed is known for making subtle statements with loaded messages, and also that it spared Bank of America rivals such as JPMorgan Chase (NYSE: JPM) or Goldman Sachs (NYSE: GS) passed their own stress tests without such words of caution from the Fed.
For Bank of America, this means more rigorous testing, which is at best a massive drain on time and resources while also raising uncertainty about its long-term outlook, and at worst signs that Bank of America isn’t as well prepared to whether an economic downturn.
Look at the Big Picture
For investors, making sense of the warning is a little like reading tea leaves. It’s unclear what exactly is driving the Fed to test Bank of America so harshly but it’s worth noting that this bank has consistently had a tough go with the stress tests that were imposed in the wake of the last financial meltdown that left many of the “too big to fail” banks too weak to survive on their own. This latest stress test on Bank of America, in fact, was conducted in response to deficiencies identified in the last one.
Here are some things for investors to keep in mind:
Bank of America’s overall business is showing signs of improvement. In its latest quarter, the bank reported a slight drop in revenue but returned to profitability amid strong growth in deposits, mortgages and home equity loan originations.
The bank needs to do better before it can raise its dividend. Last year, the Fed determined that Bank of America was strong enough to raise its quarterly dividend to five cents per share from one cent previously. But that’s still a far cry below the 64 cents per share it was paying before the financial crisis. To some extent, it doesn’t matter how well the bank is performing, a much as how the Fed is judging its performance. Until it gets the green light from the Fed, B of A’s dividends will be lackluster.
Higher interest rates present another wild card. Given that Bank of America gets so much of its business from mortgages, its future performance will depend largely on how consumers respond to rising rates and whether they rush to buy before rates go higher or pull back.
For a bank that appears to be just getting by on the Fed’s stress test, this is a real concern.
A future recession is a real concern. As the Great Recession of 2008 fades into distant memory, it’s worth keeping in mind that these stress tests were put in place to avoid the banking collapse that resulted from that last downturn.
Today, with the economy relatively stable, it’s easy to think of these stress tests in the abstract.
But at a time when some economists think another recession may be on the horizon, the Fed’s concerns about Bank of America should not be dismissed.
For Bank of America investors, the best course of action might be to follow the Fed, and proceed with caution.
This article is brought to you courtesy of Andrea Pettis from Wyatt Research.