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Bank Stocks Soar Heading Into Stress Test Results

Updated from 1:12 p.m. ET with later market action.

NEW YORK (TheStreet) -- JPMorgan Chase (JPM - Get Report) and Comerica (CMA - Get Report) of Dallas were the winners among large-cap bank stocks Wednesday afternoon, as investors looked forward to the expected announcement of annual stress tests results by the Federal Reserve after the market close.

JPMorgan's stock was up 3.5% to $60.33, while Comerica was up 3.8% to $52.42.

The KBW Bank Index (I:BKX) was up 2.4% in afternoon trading to 73.02, with all 23 component stocks showing gains, except for New York Community Bancorp (NYCB), which was flat, at $16.24.

Must Read: Banking Sector Outperforms on 'Fed Day'

The Fed's annual stress tests have become something of an annual catalyst for bank stocks, since most of the banks subject to the tests announce increases in dividends and plans to buy back shares, after the process is completed. But today's announcement only represents the first part of the process.

The first part, known as the Dodd-Frank stress tests, measures large banks' ability to remain well capitalized through a "severely adverse" economic scenario. This year's scenario assumes an increase in the U.S. unemployment of four percentage points, with the unemployment rate peaking at 11.25% in mid-2015. The scenario also includes a decline in real U.S. GDP of nearly 4.75% through the end of 2014, a 50% decline in equity prices and a 25% decline in home prices.

The severely adverse scenario also has international components, including recessions Europe and Japan, and slowing growth in Asia. For the U.S.-owned holding companies being tested, this part of the scenario is most important for Citigroup, which derives the majority of its revenue and earnings from outside North America.

The second part of the stress tests is the Comprehensive Capital Analysis and Review (CCAR), which applies banks' plans to deploy excess capital through dividend increases, stock buybacks and/or acquisitions to the same "severely adverse" scenario.

For bank-stock investors, CCAR is the more important part of the stress-test process. The Fed will announce those results on March 26, with most of the stress-tested banks expected to announce dividend increases and/or stock buyback plans the same day.

This year the Fed has increased the number of banks undergoing the stress tests and CCAR, with Comerica among several regional banks being added.

This year's stress tests incorporate two new major elements for the largest U.S. banks. For global systemically important financial institutions (G-SIFIs), including JPMorgan, Bank of America(BAC), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS), Morgan Stanley (MS), Bank of New York Mellon (BK) and SunTrust (STI), the severely adverse scenario will include instant default of a bank's largest counterparty for trading of swaps and other derivatives.

The second new element is the "Global Market Shock" component of the severely adverse economic scenario, which the Federal Reserve describes as "one-time, hypothetical shocks to a large set of risk factors." This part of the tests apply to the "big six" U.S. banks, including JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.

Citigroup is unique among the big six in deriving the bulk of its earnings from outside the U.S. Please see Could Citigroup Have the Stress-Test Hiccups?, for more on the bank's risk and opportunity from the stress tests.

Sell-side analysts expect JPMorgan Chase and Comerica both to pass the first round of the stress tests with flying colors.

Following CCAR, KBW analyst Christopher Mutascio expects JPMorgan Chase next Wednesday to be approved for $7.260 billion in common-share buybacks from the second quarter of 2014 through the first quarter of 2015. That would be an increase over actual buybacks for the prior-year period of $3.928 billion, according to KBW's estimate. Mutascio also expects JPMorgan to receive approval to raise its quarterly dividend to 41 cents a share from 38 cents.

KBW analyst Brian Klock expects Comerica to receive approval to repurchase $2.0 billion in common shares from the second quarter of 2014 through the first quarter of 2015, up from an estimated $956 million during the prior-year period. Klock also estimates Comerica will raise its quarterly dividend to 22 cents from 17 cents.

This chart shows stock returns for JPMorgan and Comerica against the KBW Bank Index and the S&P 500 (^GSPC) since the end of 2011:

JPM Chart data by YCharts

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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