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Banks undergoing 'real stress test' as recession fears continue

Brian Cheung

The largest U.S. banks were hammered by investors during last month’s coronavirus-induced market rout, but one bank analyst says he could see the industry bouncing back by next year.

Mike Mayo, a senior bank analyst for Wells Fargo Securities, told Yahoo Finance on Tuesday that the largest banks will “pass this real stress test” and could rebound to double-digit returns by the second half of next year. 

“They’ll do so without having to raise equity by still earning their dividend and coming out of the other side as being part of the solution as opposed to the problem,” Mayo told Yahoo Finance’s “On The Move.”

The U.S. banking industry is in the midst of an economic downturn that resembles the Federal Reserve’s regular stress tests, in which regulators apply a “severely adverse” economic scenario to a bank’s balance sheet. 

A homeless man sleeps in a closed Chase bank branch on a nearly deserted Wall Street in the financial district in lower Manhattan during the outbreak of the coronavirus disease (COVID-19) in New York City, New York, U.S., April 3, 2020. REUTERS/Mike Segar TPX IMAGES OF THE DAY

The Fed’s 2020 test examines the ability of banks to survive a macroeconomic shock where unemployment rises to as high as 10% and real GDP falls about 8.5% from its recent peak.

That hypothetical may pale in comparison to the real-world economic impact of the coronavirus. Former Fed Chair Janet Yellen told CNBC Monday that she could see the unemployment rate rising as high as 13% with GDP falling 30% or more.

Mayo said banks will face continued pain as business closures and layoffs en masse impair the ability of banks to collect interest. But he expects the industry to eventually bounce back.

“They come into this recession stronger than they’ve been,” Mayo said. “But we still think there’s issues.”

Sobering times

Mayo’s most updated projections have credit losses doubling or tripling as a result of the continued business disruptions from the virus. Mayo also projects at least a 25% decline in net interest margin, a key bank measure of interest earned on loans subtracted by interest paid on deposits.

“These are sobering times, this is difficult, so banks bear the brunt of that,” Mayo said.

Banks have felt the pain, and saw a deeper sell-off than the broader market during the heightened volatility in late March. Shares of all four of the nation’s largest banks — JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup — fell more than 40% from where they traded at the start of the year. The S&P 500 had fallen over 30% during that time.

The S&P 500 has since rebounded but the large banks are still struggling to catch a bid, as all four of the banks continue to log over 30% year-to-date losses as of Tuesday afternoon.

Mayo said he expects the banks to see lower bottom-line results in the coming quarters, projecting a 40% cut in their earnings estimates.

But Mayo said that as long as the government can effectively handle the virus, he could see banks continuing to grow their book values. He projects return on tangible common shareholders’ equity bouncing back to the double digits by the second half of next year.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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