Bank Stocks to Benefit From More 'Stress': Goldman

Updated with Federal Reserve release of broad guidelines.

NEW YORK ( TheStreet) -- Obama's re-election might have spoiled the party for bank stocks, but a catalyst is just around the corner.

The Federal Reserve on Friday released instructions for the upcoming 2013 CCAR (Comprehensive Capital Annual Review)- the stress test that is annually run on big banks to ensure that they are well-capitalized for an adverse economic scenario.

Passing the test with flying colors reassures investors about the bank's safety, crucial in the aftermath of the financial crisis. Depending upon how a bank fares in the test under hypothetical adverse scenarios, the Fed also decides whether it can go ahead with its dividend and buyback plans.

Almost all banks passed the stress test in 2012, but a few, notably Citigroup ( C) did not receive the regulator's go-ahead for its buyback plan. In 2011, Bank of America's ( BAC) request for capital returns was rejected. In 2012, the bank decided against making a similar request for approval.

Bank CEOs have learnt that they can't be too cocky about their capital deployment plans, as the Fed' models differ from their own.

However, the Fed this time around has made one concession. While the regulator will still not share its model, it will permit CCAR banks to make "a downward adjustment" to their initial capital distribution plans before the Fed makes a final decision.

The Fed will release the economic scenarios under which the banks will be tested on Nov. 15. Banks have until Jan.7 to submit the plan.

Analysts at Goldman Sachs said in a report earlier Friday that banks are likely to do well in the 2013 review, entering the year "from a position of strength" given higher capital levels and reduced risk in loan books.

"Tier 1 common has grown from 10% to over 11% for CCAR banks, which implies that, all else equal, cumulative loss rates can increase 250bp or 30% given the higher starting point. Additionally, loss rates should benefit from a loan mix shift away from home equity/card and into C&I," analyst Richard Ramsden said in a note.

According to their analysis, banks can pay between 50% and 75% of their earnings and still maintain a Tier I Capital ratio above the stipulated minimum of 5%.

However, risks remain including the possibility that the Fed will ask banks to incorporate Basel 2.5- a more conservative framework of measuring capital, which the analysts estimate could lower stressed capital by 100 to 300 basis points. That means a lesser cushion for banks to return capital.

Regulators could also adopt a more stringent treatment of deferred tax asset arising from stressed losses, "effectively removing the tax shield for some banks and making stressed losses a one-for-one hit to capital."

"Regulators could also reduce capital deployment through the qualitative aspect of the stress test, something that remains difficult to handicap," the analysts add.

Banks with the largest potential increase from last year include Citigroup, Regions Financial ( RF), KeyCorp ( KEY), SunTrust ( STI), Discover Financial ( DFS) and Northern Trust ( NTRS).

Morgan Stanley ( MS) also screens well, but the analysts expect the investment bank to prioritize completing the acquisition of Morgan Stanley Smith Barney.

In addition, the analysts also include banks with the highest "margin of error"- banks that could afford to see their loan losses increase 50% or operating profit drop 50%, maintain a payout ratio of 50% and still maintain a common capital of 5.5%.

American Express ( AXP), Citigroup, KeyCorp, Morgan Stanley and all the trust banks meet this criteria.

-- Written by Shanthi Bharatwaj in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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