Capital One Leads Bank Stocks After Stress Tests

NEW YORK (TheStreet) -- Capital One Financial (COF) was the winner among large-cap U.S. banks on Friday, with shares rising 1.5% to close at $75.40.

The broad stock indices all ended with declines. The KBW Bank Index (I:BKX) pulled back 0.3% to 72.20, although all but seven of the 24 component stocks ended with gains, following the release of the results of the first part of the Federal Reserve's annual bank stress tests right after Thursday's market close.

Thursday's results covered the Dodd-Frank Act Stress Tests (DFAST) on 30 large holding companies, with all but Zions Bancorporation (ZION) of Salt Lake City showing they could remain well-capitalized, with Tier 1 common ratios of at least 5.0% through a nine-quarter "severely adverse" economic scenario.  Shares of Zions were down nearly 5% to $31.38 after the Salt Lake City lender failed its stress test.

The second part of the stress tests is called the Comprehensive Capital Analysis and Review (CCAR), and incorporates the banks' annual plans to deploy excess capital through dividends, share buybacks and/or acquisitions. Those results will be announced at 4 p.m. ET on March 26, with most of the tested banks expected to make their own separate announcements of dividend increases and stock-buyback plans soon after.

Discover Financial Services (DFS) was among 12 banks joining the original group of 18 banks subject to DFAST and CCAR, and jumped the gun by announcing plans to increase its quarterly dividend to 24 cents a share from 20 cents, and to repurchase up to $1.6 billion in common shares from the second quarter of 2014 through the first quarter of 2015. While Discover passed DFAST with a very strong minimum Tier 1 common equity ratio of 13.1% through the severely adverse scenario, investors won't know if the capital plan is approved until next week.

Janney Capital Markets analyst Sameer Gokhale expects Discover's capital plan to be approved, and in a client note Friday wrote that "the announcement suggests that Discover has already received a favorable quantitative assessment from the Federal Reserve."

This year's severely adverse 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 scenario includes 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 (C), which derives the majority of its revenue and earnings from outside North America.

In addition to expanding the list of banks being tested, the Fed introduced new elements for the largest banks that are considered global systemically important financial institutions (G-SIFIs). The tests for these banks factor in the instant default of a bank's largest counterparty for trading of swaps and other derivatives.

For much more on the first round of stress tests, Zions Bancorporation's failure and response and results for Bank of America and Citigroup, please see Bank of America 'Struggles' in Stress Test.

Capital One

Shares of Capital One have pulled back 1.2% this year, following a 34% return during 2013.  The shares trade for 1.8 times their reported Dec. 31 tangible book value of $42.47, and for 10.4 times the consensus 2015 earnings estimate of $7.28, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $6.81.

Based on a quarterly payout of 30 cents, the shares have a dividend yield of 1.59%.

Capital One passed the first round of the stress tests with a minimum Tier 1 common equity ratio through the nine-quarter severely adverse economic scenario of 7.6%.

"As for COF, while the company handily exceeds expectations under the DFAST, if we were to layer in our capital actions as best as we can, we think the company definitely is a closer call than AXP and DFS. However, it appears the company has a decent buffer even at the minimum capital levels relative to our assumption of a $2 billion annual share buyback. We remain optimistic of our capital return assumptions," KBW's bank analyst team wrote in a note to clients Friday.

KBW analyst Sajay Sakhrani has also estimated Capital One will raise its quarterly dividend to 35 cents.

This chart shows the performance of Capital One's stock against the KBW Bank Index and the S&P 500 since the end of 2011:

COF 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 TheStreet.com 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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