3 Stress-Test Approved Stocks For Your Portfolio

Source: Thinkstock

Source: Thinkstock

The nation’s largest financial institutions received another stamp of approval from the Federal Reserve. Almost every bank holding company involved in the latest round of stress tests satisfied the minimum capital requirements set by the central bank. The results suggest the financial system has improved from the credit crisis, but some banks are clearly stronger than others.

When faced with a hypothetical severe economic downtown, the Federal Reserve said twenty-nine of the thirty largest institutions have adequate capital to keep lending to clients and meet their financial commitments. Zions Bancorp (NASDAQ:ZION), a regional lender based Utah, was the only firm to not receive the Federal Reserve’s blessing. Its minimum Tier 1 common ratio came in at 3.5 percent, below the 5 percent standard. Collectively, the thirty banks would lose $501 billion under a severe recession lasting nine quarters and $355 billion under a less severe downturn.

“The annual stress test is one of the Federal Reserve’s most important tools to gauge the resiliency of the financial sector and to help ensure that the largest firms have strong capital positions,” said Federal Reserve Governor Daniel K. Tarullo. “Each year we are making substantial improvements, which have helped make the process even stronger than when we first conducted the stress tests in the midst of the financial crisis five years ago.”

A severely adverse scenario involves a deep recession in the United States, Europe, and Japan, along with a slowdown in developing Asia. It also has America’s real gross domestic product declining nearly 4.75 percent between the third quarter of 2013 and the end of 2014, headline unemployment peaking at 11.25 percent in the middle of 2015, equity prices plunging nearly 50 percent, and house prices falling 25 percent. Let’s take a look at three financial institutions that received the green light during these conditions that investors may want to consider for their portfolios.

1. Wells Fargo (NYSE:WFC)

Founded in 1852, Wells Fargo is a diversified financial services company and the nation’s largest mortgage lender. The bank has more than 9,000 locations and more than 12,500 ATMs. Wells Fargo’s Tier 1 common ratio dropped to as low as 8.2 percent under the Federal Reserve’s severely adverse scenario, easily beating other major banks such as Citigroup (7 percent), JPMorgan Chase (6.3 percent), and Bank of America (6 percent).

In the fourth quarter of 2013, Wells Fargo reported net income of $5.6 billion, up 10 percent from a year earlier. For the full year, Wells Fargo earned $21.9 billion, making it the most profitable bank in America. Euromoney named Wells Fargo “Best Bank” in its 2013 Global Awards for Excellence, the first time a U.S.-based bank has won the top award.

“Wells Fargo had another outstanding year in 2013, including strong growth in loans and deposits, and double-digit growth in earnings,” said Wells Fargo CEO John Stumpf, in a press release. “In the five years since our merger with Wachovia, we have grown our businesses, invested in our franchise’s future and contributed to the U.S. economy’s recovery. Our 264,000 team members made it possible through their strong commitment to our consumer, small business and commercial customers, and the communities they serve around the world. Strong earnings power and capital levels, and an improving economic outlook are major reasons why we look ahead to 2014 with optimism.”

2. Discover Financial Services (NYSE:DFS)

Discover is a direct banking and payment services company. Since its inception in 1986, Discover has become one of the largest card issuers in the United States, and one of the most recognized brands in the financial industry. Discover’s Tier 1 common ratio fell to as low as 13.1 percent in the stress test, which was tied for the second highest score out of the 30 institutions. In comparison, American Express and Capital One Financial posted scores of 12.6 percent and 7.6 percent, respectively.

The upbeat stress test results also provided a catalyst for Discover’s new capital plan. Discover recently announced a proposal to increase the company’s quarterly dividend from 20 cents to 24 cents per share, and repurchase up to $1.6 billion in shares during the four quarters ending March 31, 2015. The proposed capital actions in Discover’s capital plan are subject to the receipt of a non-objection from the Federal Reserve on March 26, 2014.

Looking ahead, Discover looks poised to please investors and customers. It was recently named a top stock by Credit Suisse, and shared the top spot in the credit card category this year on the 2014 Brand Keys Customer Loyalty Engagement Index — a survey of 32,000 consumers. Discover has held or shared the top Brand Keys ranking in its category for the past eighteen consecutive years.

3. State Street (NYSE:STT)

State Street is a world leader in financial services and provides a wide-range of products and services to customers around the globe. Clients include mutual fund companies, investment managers, public pension funds, unions, non-profit organizations, families, individuals, and some of the largest corporations in the world. State Street was founded as a bank in 1792 in Boston, Massachusetts. It has more than $27 trillion in assets under management.

Under the Federal Reserve’s stress test, State Street received the highest score among the thirty institutions, with a Tier 1 common ratio of 13.3 percent. Bank of New York Mellon, one of State Street’s main competitors, was a close second at 13.1 percent. Northern Trust’s ratio was 11.4 percent.

Low interest rates and added regulations have served as headwinds for State Street in recent years, but the company has conducted numerous cost-cutting activities to reduce expenses, and the bank continues to grow fees. State Street CEO Joseph L. Hooley explained in a recent press release, “2013 was a very good year for State Street despite both the ongoing headwinds created by the low rate environment and the increasing regulatory cost and complexity. Importantly, for the full year, we grew our core asset servicing and asset management fees by almost 10 percent compared to 2012.”

Hooley added, “Our results for 2013 also demonstrated our commitment to controlling expenses which enabled us to achieve 171 basis points of positive operating leverage for full-year 2013 compared to full-year 2012.”

More From Wall St. Cheat Sheet:

Follow Eric on Twitter @Mr_Eric_WSCS