Good Bank, Bad Bank — How to Invest After Fed’s ‘Stress Tests’

BankDuring the financial crisis and for months afterward, the entire banking industry seemingly moved in lockstep. But recently there has been some substantial differentiation between some of the bad banks and the “better” banks.

Consider that in the past 12 months, Wells Fargo (NYSE:WFC) is up about 3% and JPMorgan Chase (NYSE:JPM) is down just 5% — while Citigroup(NYSE:C) is off an ugly 20% and Bank of America (NYSE:BAC) is down 40%.

After the Federal Reserve’s latest “stress test” — released Tuesday after the bell, two days earlier than originally planned — it appears that differentiation is only getting more pronounced.

Recently I asked the question “Is it finally safe to invest in bank stocks?” and then outlined the 5 biggest risks and 5 biggest opportunities for the financial sector right now. But it’s worth noting that banking stocks, like so many other groups of investments on Wall Street, are not cut from the same cloth.

First, consider that a number of big-name institutions passed with flying colors. Head of the class is JPMorgan Chase, which continues to prove that it has made the most of the turmoil in the financial sector. The financial stock, run by the shrewd but sometimes abrasive CEO Jamie Dimon, on Tuesday announced plans to increase its quarterly dividend by 20% and will buy back as much as $15 billion of its shares.

This is a year after the Federal Reserve authorized a 500% increase in the JPM dividend — from a nickle a share to 25 cents quarterly — after similar “stress tests” in early 2011.

As a result of its recent strength, JPM actually is trading around the same levels it was in 2007 before the financial crisis gripped Wall Street. BofA is off over 80% since then, and Citi is off over 90%. In fact, the financial crisis might have been “good” in a way for JPMorgan Chase, since it bought up troubled bank Washington Mutual for $1.8 billion — a fire-sale price in hindsight. Thanks in part to this acquisition, JPM surpassed Bank of America late last year as the largest U.S. bank by assets.

Of course, for all of JPMorgan’s strength, there remain serious issues for a host of other banks.

Take Citigroup. Citi didn’t meet the 5% “Tier 1” capital requirement — a kind of rainy day fund in case of market turmoil — set aside under a measure called Tier 1 capital ratio, according to a Fed release Tuesday. Then there’s Bank of America, which was denied a dividend increase in 2011 and saw its shares punished severely as a result. BofA didn’t even bother asking for permission from the Fed this time around.

SunTrust Banks (NYSE:STI) and MetLife (NYSE:MET) also got poor marks from the Federal Reserve and appear to be ready for a beating in Wednesday trading.

So what is the lesson here? Well, it’s deceptively simple: The Federal Reserve tests are certainly not the end-all measure for financial stocks, but are a good example of how banks continue to diverge in their health and growth potential.

There are assuredly major risks to the sector as a whole. The five biggest risks include:

  • The impact of capital requirements
  • The Volcker rule
  • Lingering bad debt and writedowns
  • Interbank confidence
  • Populist backlash

And the five biggest opportunities for the sector are:

  • Decent dividends for a change from some banks
  • Regulator approval (vis a vis the stress test findings)
  • The “smart money” bidding up shares
  • Broader recovery spurring lending
  • The sector’s stronger members

You can read more in my recent in-depth column on the risks and rewards of the banking sector. But one thing that remains clear is that whatever the broader outlook for the sector is, you must invest knowing that not all banks are created equal these days.

Jeff Reeves is the editor of Write him at, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.

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