Investors should savor the dividends and buybacks coming from big U.S. banks right now. They might not get the same kind of boost next year.
Following last week’s Federal Reserve stress-test results, which banks passed with room to spare, banks on Monday evening unveiled a host of increased dividends and expanded share-repurchase plans. This is very good news for shareholders who stuck with bank stocks last year, betting on these capital returns, when they were beaten up and restricted from big payouts. But to bet even more after this might require increasing faith in the underlying economics of lending.
For one, earnings growth isn’t for now expected to be the tailwind it has been recently. It has been driven in part by a wave of Wall Street activity that could crest, while rates and loans are only ticking higher slowly. Analysts’ estimates of earnings per share for S&P 500 banks are currently lower for 2022 than 2021, according to FactSet.
Banks still likely have more loan-loss reserve releases to come. That will certainly boost earnings, but it will have a somewhat more limited benefit on capital levels because banks were allowed by regulators to delay some of the negative effects of reserving on capital during the pandemic. Releases also mean that banks would have smaller loss cushions for next year’s stress tests. Presumably, though, if economic conditions continue to improve markedly, the test scenarios also will get a bit less dire.
Meanwhile, capital requirements not related to stress tests also might start to squeeze more. The biggest banks’ required extra capital buffers due to their global systemic importance look to be on the rise. Meanwhile, huge deposit inflows have also pushed banks closer to their leverage-ratio limits. The Fed could recalibrate all these rules, but the likelihood or outcome of those tweaks is tough to forecast.
Investors who prize shareholder payouts may need to start digging a bit more into the nitty-gritty.
Goldman Sachs Group,
for example, is working to reduce its capital intensiveness by shifting away from owning alternative investments to managing them via funds to earn steady wealth-management fees. It might be able to outperform on future stress exams and lower its requirements by shedding more of those volatile assets, independent of other macroeconomic factors.
That potential may also come cheaply next to
which is further along the wealth-transformation road and already trades at a valuation premium. Morgan Stanley on Monday said it would double its dividend and add to its buyback capacity to “reset” its capital base; Goldman bumped up its dividend by a smaller percentage and didn’t add to its existing buyback plan.
In general, though, investors might just need to start to change their frame of reference on capital—especially if they are inclined to believe that the economy is improving, which would lead to loan growth and higher rates. Bigger can often be better in banking. Banks that slim down too much to free up capital to return might start to sacrifice longer-term earnings power at just the wrong time.
Ultimately it isn’t the capital that really matters to investors but the return on capital.
Write to Telis Demos at firstname.lastname@example.org
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