US large banks* announced significant dividend increases and share buyback authorizations following the announcement of this year’s Federal Reserve stress test results on June 27th. In aggregate, the twelve largest US banks will have dividend yields of 3.2% and authorization to buyback 9.3% of their outstanding stock over the next twelve months. Relative to last year, dividends for the group are up 9.5%. The buyback increase is even more dramatic—the total repurchase authorization is 25% higher for the twelve largest banks, driven by massive increases at Bank of America and JP Morgan.
By our calculations, the twelve US large banks are expected to payout 32% of earnings in dividends over the next twelve months. This dividend payout ratio is not noteworthy relative to other industries, suggesting that dividends can continue to increase in coming years. The level of share buybacks is, however, quite unusual. The Federal Reserve’s buyback authorization this year represents 124% of earnings (for the group) over the next 12 months. The clear message from the Fed is that the US banking system is still overcapitalized after years of building safety buffers.
Has the Fed gone soft? Judging by the severely adverse scenario that formed the basis of the Fed’s analysis, the answer is no. The stress test this year included:
- 50% equity market drop
- 25% home price drop
- 35% commercial real estate price drop
- 10% unemployment
Each bank’s balance sheet was tested to see if it could withstand the credit defaults that would accompany this severely adverse scenario. The twelve largest US banks all performed well in the stress test, giving bank regulators the confidence to allow the high return of capital. JP Morgan and Capital One had to moderate their initial requests (using the so-called ‘Mulligan provision’), but this likely reflects aggressive initial asks more than anything else.
The news for mid-sized banks** with assets between $100 billion and $250 billion was not quite as clear. These banks were allowed to use the 2018 stress test results as a basis for their 2019 dividend and share repurchase requests. Some of these banks issued press releases with their approved capital plans on June 27th following the Fed’s announcement on large banks. Others did not. Note that all mid-sized banks passed the test in 2018, so we don’t believe there’s bad news lurking from a regulatory perspective. What we do not know is exactly how much dividends and buybacks will increase for these mid-sized banks. For the mid-sized banks that have made announcements, capital return plans are roughly in-line with the large banks.
Overall, our investment thesis for banks remains in place. Both dividends and share repurchases remain well-above the levels found in the market as a whole. Concerns about safety are mitigated by the results of the Federal Reserve stress test. While the risk of widespread loan defaults will always exist, we believe US banks have now built a substantial capital buffer that should allow them to continue paying dividends in all but the most extreme circumstances.
*US large banks are those with assets greater than $250 billion and include: Bank of America, Bank of NY-Mellon, Capital One, Citigroup, Goldman Sachs, JP Morgan Chase, Morgan Stanley, Northern Trust, PNC, State Street, US Bancorp, and Wells Fargo.
**US mid-sized banks are those with assets between $100 billion and $250 billion and include: Ally Financial, American Express, BB&T, Citizens Financial Group, Discover Financial Services, Fifth Third Bancorp, Huntington Bancshares, Keycorp, M&T Bank, Regions Financial Corporation, and SunTrust Banks.
Dividend increases and buybacks are based on announcements in company press releases.
Source: The Federal Reserve, Bloomberg, company press releases, and Miller/Howard Research & Analysis.
As of June 27, 2019: JP Morgan was held in Miller/Howard strategies; Bank of America and Capital One were not held in Miller/Howard strategies.
This information should not be considered a recommendation to buy, sell or hold any of the securities and is not intended to imply that any one security listed above, or the portfolio as a whole, is suitable for a particular client. There is no assurance that the securities have remained or will remain in the portfolio. It should not be assumed that any of the above securities were or will be profitable or that investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed.
