Time for Bank ETFs After Successful Fed Stress Test?

U.S. banking biggies have cleared the key Stress Test conducted by the Federal Reserve in 2022.The results of the stress test dictate how much capital banks need to be healthy and how much they can return to shareholders.

The annual stress tests were established by the Fed, following the 2008 financial crisis, as a measure to ensure that banks could withstand any similar shock in the future. The balance sheets of major banks like JPMorgan (JPM), Bank of America (BAC), Citigroup (C) and Goldman Sachs (GS) are tested against an extremely hypothetical economic downturn, the elements of which change annually.

This year, all of the 34 biggest lenders that have been tested have cleared the results. The 2022 stress tests’ focus is on an employment crisis that sends the jobless rate to more than 10% for at least two years, plus a 40% drop in commercial real estate prices.

While this year’s scenarios were devised before the Russia-Ukraine conflict and the current red-hot inflation, they indicate that the banks are well-prepared for a potential U.S. recession, which is predicted for later this year or next year.

According to the central bank, under this year’s hypothetical severe downturn, the 34 lenders, which have more than $100 billion in assets, will likely suffer a combined loss of $612 billion. Still, the banks would have roughly twice the amount of capital with them than required under the rules.

Most U.S. big banks have been seen raising CET1 ratio in next 18 months. This means the amount of high-quality common equity tier one capital, or CET1, they will have to hold relative to their risk-weighted assets should be in excess of regulatory minimums.

Jefferies analysts forecast that of the six largest US banks by assets — JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman and Morgan Stanley — all except Morgan Stanley will increase or maintain their current CET1 ratios by the end of 2023, according to Jefferies estimates,, as quoted on Financial Times.

Jason Goldberg, banking analyst at Barclays believes that “this stress test has the potential to prove that the industry is well-positioned to handle a very devastating scenario, something much worse than anyone’s predicting,” as quoted on Financial Times. Analysts expect dividend payments to rise this year but predict the clip of share buybacks at the biggest banks will be sluggish, per the FT article.

If these were not enough, rates are rising in the United States. A rising rate environment will lead to a favorable operating environment for financial stocks. Since banks borrow money at short-term rates and lend capital at long-term rates, an uptick in long term rates is good for banking operation. Also, banking stocks offer value now.

A Few Big Banks Raised Dividends

Morgan Stanley, Goldman Sachs, Bank of America and Wells Fargo hiked their dividends on Monday after the U.S. banks cleared their annual stress test exercise last week.

ETFs in Focus

Investors may be interested in investing in ETFs heavy on J.P. Morgan, Citigroup and Wells Fargo. These areiShares U.S. Financial Services ETF IYG, Financial Select Sector SPDR Fund XLF, Vanguard Financials ETF VFH and Fidelity MSCI Financials Index ETF (FNCL).

Citigroup and Wells Fargo have special exposure to Invesco KBW Bank ETF KBWB.Goldman and Morgan Stanley have substantial weight iniShares US Broker-Dealers ETF IAI.

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Financial Select Sector SPDR ETF (XLF): ETF Research Reports
 
Invesco KBW Bank ETF (KBWB): ETF Research Reports
 
iShares U.S. BrokerDealers & Securities Exchanges ETF (IAI): ETF Research Reports
 
iShares U.S. Financial Services ETF (IYG): ETF Research Reports
 
Vanguard Financials ETF (VFH): ETF Research Reports
 
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