NEW YORK ( TheStreet) -- The results of the bank stress tests to be announced next week is expected to further ignite bank stocks, but given the sharp run-up in prices in the last two months and continuing overhang from Europe and regulatory issues, investors may have reason to be cautious.
The Federal Reserve's Comprehensive Capital Assessment and Review is an annual test conducted by the regulator to assess whether the country's largest banks can withstand a massive shock to the economy.
Banks will have to show that they can still maintain a Tier 1 Common Capital ratio of at least 5% even if they end up absorbing substantial losses in the event of a severe economic downturn. The harsh scenario includes a GDP contraction of 8%, a further decline in housing prices of 20% and an equity market crash of more than 50%.
Banks will also have to show that they are on track to meeting their capital requirements under new international rules or Basel 3.If the Fed is satisfied with the tests, it will go ahead and approve banks' requests to return capital to shareholders, either by way of dividend increases or buybacks or both. Analysts have largely been positive that banks will pass the stress tests and that most will win approval for their capital return plans. "The big message that will come out of the stress tests is that American banks are highly liquid, they have an excessive amount of capital and that they can withstand a fairly sizeable setback in the economy," Rochdale Securities analyst Dick Bove told Yahoo Finance's Breakout. "The second thing that will happen in week following the stress tests is that banks across country are going to be raising dividends and some will be announcing buybacks . I am assuming it is going to be a big buy signal for bank stocks and I will be shocked if it were not." Still, after a 35% rally in the KBW Bank Index, the stress test may not be such a positive catalyst. The expectations of who is poised to win from the stress tests vary widely as also estimates of how much banks will return to shareholders.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV