Before the Move: Watch Wells Fargo, Citi into 2023 stress test results

The Federal Reserve is expected to release 2023 stress results on Wednesday after the market close, with a total of 23 banks having participated in the stress test. BofA believes Wells Fargo (WFC) and Citi (C) are the bank stocks to watch as the former is coming into the stress test with a cushion over the minimum requirements and the latter could benefit if stress test results clear the way for sustainable share buyback “self-help.”

STRESS RESULTS: In a research note ahead of the Fed release, BofA noted that banks are coming into 2023 stress results with 185 basis points of excess common equity tier 1, or CET1, capital versus regulatory minimums. As a result, the ability of the banks to absorb an increase to their stress capital buffer, or SCB, which is the determinant of the minimum capital requirement, is significant, the firm said. Of the 23 banks participating in the stress test, Capital One (COF), Northern Trust (NTRS) and State Street (STT) have the largest buffers over minimum CET1 requirements, said BofA.

The firm further noted that this year’s stress test includes an “exploratory market-shock.” Although the outcome will not impact capital requirements, it could pave the way for a potential move towards a multi-scenario approach. BofA believes that any changes that reduce the risk of surprises on capital requirements coming out of stress test results, which in turn risk a knee-jerk reaction from the banks on capital deployment, would be a welcome change.

Wells Fargo is coming into the stress test with about 160 basis points of cushion over the minimum requirements, according to BofA. An increase in the SCB of less than 50 basis points should be viewed positively, according to the firm, which also sees potential for Wells to raise its 2023 net interest income guidance when they report in July. It sees the stock as offering one of the best risk/rewards to gain exposure to bank sector themes. Citigroup shares could also benefit if stress test results clear the way for sustainable share buyback “self-help,” the firm added.

RESULTS COULD BE ‘A LITTLE WORSE’: While most banks have capital ratios above their current requirements and the harder scenario in this year’s stress test has been known for several months, Evercore ISI thinks the results being posted this week could be a little worse than expectations as one could see a “Fed Finish” on the SCB as Basel III Endgame could be hotly contested and take years to fully implement. Besides the all-in SCB for each bank, the firm thinks all eyes will be on the Fed’s loan loss rate expectations, particularly for commercial real estate, or CRE. Evercore reminds investors that Capital One and Goldman Sachs (GS) had the highest Fed projected loan loss rates last year, while Bank of New York Mellon (BK), Morgan Stanley (MS), and Bank of America (BAC) had the lowest.

Evercore still thinks higher SCBs, lower buybacks and the overall macro backdrop will continue to keep the generalist investors uninterested in the group. As for CCAR as an event itself, the firm could see Bank of America, Wells Fargo, and M&T Bank (MTB) faring better than the group and is “a little concerned” Citi and U.S. Bancorp (USB) have a more adverse result.

PRICE ACTION: Shares of most banks have fallen into negative territory on Wednesday, with Wells Fargo, Citi, Bank of America, Morgan Stanley, U.S. Bancorp, and Bank of New York Mellon dropping about 1%.

“Before the Move” is The Fly’s recurring series of exclusive stories that identify potentially market moving events, along with analyst predictions, ahead of the news.