Banking Sector Outperforms on 'Fed Day'

NEW YORK (TheStreet) -- Regions Financial (RF) of Birmingham, Ala., was the winner among major U.S. banks on Wednesday, with shares rising 2.5% to close at $11.09.

The broad indices all ended with significant losses after the Federal Open Market Committee released its first policy statement since Janet Yellen took over as Federal Reserve chairwoman in on Feb. 1.

But most bank stocks ended higher. The KBW Bank Index I:BKX rose 0.8% to 71.32, with all but three of the 24 index components ending with gains. Large banks seeing shares rise 2% included Bank of New York Mellon (BK), which closed at $34.15, and Comerica (CMA) of Dallas, which closed at $50.51.

As expected, the FOMC said the Federal Reserve would lower its monthly "QE3" net purchases of long-term U.S. Treasury bonds to $30 billion from $35 billion, while lowering its monthly purchases of long-term agency mortgage-backed securities to $25 billion from $30 billion, for total monthly purchases of $55 billion. The bond purchases ran at a monthly pace of $85 billion from September 2012 through December 2013. The FOMC announced the tapering of purchases to a monthly pace of $75 billion following its December meeting, with, another reduction to $65 billion announced during its meeting late in January.

The committee said "economic activity slowed during the winter months, in part reflecting adverse weather conditions," and added that the labor market in the United States "on balance showed further improvement."

The FOMC also changed its guidance for when it might raise the short-term federal funds rate, which has been locked in a target range of zero to 0.25% since late 2008. The committee had previously incorporated an improved U.S. unemployment rate falling below 6.5%, as part of its criteria for considering a policy change. But the U.S. unemployment rate improved to 6.6% in February from 6.7% in January, and Yellen had previously stated the central bank would make no move on short-term rates until after the QE3 bond purchases had ended. With the committee expected to curtail the bond purchases at a similar pace during its subsequent meetings this year, the bond purchases should end in December, making it very unlikely for the federal funds target rate to be raised before 2015.

The FOMC once again said, "a highly accommodative stance of monetary policy remains appropriate," but moved away from setting a specific unemployment-rate target. Instead, the committee said it would "assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation." The committee went further, saying "it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends."

So unless we see a significant bump in inflation, the low federal funds rate could remain in place well into 2015, and even until 2016. And even when the federal funds rate does begin to rise, "economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

Ending the bond purchases will move the Fed back toward focusing on the federal funds rate, which is its main policy tool. But in the meantime, savers will continue to feel the pain of historically low interest rates, while many banks will also feel continued pressure on their net interest margins and net interest income, certain asset classes continue to reprice at lower rates.

Stress Tests

The strong performance of bank stocks on Wednesday may have reflected investors excitement over the two-part stress test process that will end next week with most large U.S. banks announcing dividend increases and their plans to buy back shares through the first quarter of 2015.

The Federal Reserve Thursday afternoon will release the results of its annual stress tests on major bank holding companies, gauging their 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 only bank to fail last year's initial stress Ally Bank, the former GMAC.

But this year's stress test scenario incorporates some new twists, and the group of banks being tested has grown to 30 from 18, so investors will certainly be eager to see the results.

The second part of the stress test process will be more important for investors. The Fed on March 26 will announce the results of its annual Comprehensive Capital Analysis and Review (CCAR), which incorporates the banks' plans to deploy excess capital through dividends, share buybacks and/or acquisitions into the same "severely adverse" scenario. Most of the big banks next Thursday will be expected to follow the Fed's announcement with their own announcements.

Please see the following articles for more on what to expect following the stress tests:

Discover, Fifth Third Are Well-Positioned for Higher Payouts After Stress Tests

Banks' Excess Capital Is 'Absolutely a Reality'

Citigroup, Stress Tests and Shareholder Gravy

Why You Should Celebrate Bank Stress Tests

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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