So what U.S. banks will be the winners—and which the losers—when the Federal Reserve releases Round 2 of its stress test data on March 26?
Yesterday’s Round 1 looked at 30 big U.S banks to see which met the Fed’s capital targets in the event of a U.S. financial and economic crisis. Only Zions Bancorp (ZION) railed to meet the Fed’s target. In the event of a crisis Zion’s capital ratio would fall to 3.5%. That’s below the 5% minimum set by the Fed.
Today Wall Street has moved on to look at next week’s test. On Wednesday the U.S. central bank will announce which of the 30 banks on the list have won approval for their capital plans for 2014. Banks winning approval will be able to go ahead with plans for share buybacks and increased dividend payouts. Banks that fail to win approval will have to put buybacks and dividend payouts (or at least increases in dividend payouts) on hold while they resubmit plans for raising capital and for distributing it to shareholders.
Zions Bancorp isn’t the only bank in danger of getting a “No” from the Fed next week. Bank of America (BAC), Morgan Stanley (MS), Goldman Sachs (GS), and JPMorgan Chase (JPM) all came in with capital ratios below 7% in the Fed’s test. That puts them relatively close to the 5% limit and might lead the Fed to veto their plans for buybacks and dividend increases. Last year the Fed gave an initial “No” to both Bank of America and Citigroup (C). (Citigroup is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
The capital ratio under the Fed’s stress test isn’t a straightforward indicator of how the Fed will rule. The central bank will also consider the capital distribution plans submitted by individual banks and how much capital buffer any plan would leave. For example, the consensus among Wall Street analysts is that the Fed will approve the plan from JPMorgan Chase because it projects distributing only about $10 billion from the bank’s $17 billion capital buffer above the Fed’s stress test minimum.
The consensus also points to Bank of America as the closest to a potential veto. Read more
The market’s first take on the Federal Reserve’s stress test of U.S. banks has been to divide bank stocks into “naughty” and “nice.”
But I’d like to dive a little deeper and look at how banks that have been told by the Fed that they can pay out more on dividends or increase their programs of share buybacks have chosen the divide those payout streams. That’s because I think investors get a lot more reward from a dividend increase than they do from a buyback. It makes sense, to my way of thinking, to go with the banks that emphasize dividends over buybacks—all else being equal, of course.
In the market’s first cut on the Fed list banks such as Bank of America (BAC) that have received the Fed’s stamp of approval on their capital plan for stock buybacks and/or dividend increases have seen their share price move up today. Bank of America shares, for example, closed up 3.8%.
Banks that got a thumbs down from the Fed and will have to resubmit their plans closed down today. BB&T (BBT), for example, finished off 2.36%. (It’s hard to say that JPMorgan Chase (JPM) was down today because the Fed told the bank to improve its capital plan. The bank and CEO Jamie Dimon took heavy fire yesterday from a Senate report that ripped the bank’s culture and risk controls in the London Whale trading debacle. JPMorgan Chase shares closed down 1.92% today.)
But the banks that got approval to increase their buybacks or dividends have put together very different mixes.
Some banks chose to increase their share buyback programs but not to increase their dividends. Citibank (C), for example, announced a new $1.2 billion program of share purchases but kept its dividend at a penny a share. That’s not exactly a rousing vote of confidence by the bank’s management in the bank’s cash flow going forward. It’s hard—and very visible—to cut a dividend once announced. It’s much easier to announce a big buyback program and then to execute only a part of it if times turn tough. Bank of America was another bank announcing a big buyback–$5 billion—without a dividend increase.
Most of the banks that got the Fed’s approval chose a mix of dividends and buybacks. Banks that wanted to send a message of confidence to shareholders seem to have picked an increase in the neighborhood to 20%. Wells Fargo (WFC) raised its dividend by 20%. US Bancorp upped its dividend by 18%. Both banks also announced buybacks. (US Bancorp is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/)
A very few banks went for all dividends. Capital One (COF) is the standout here. The bank announced a 500% increase to 30 cents from 5 cents.
The financial sector has been a clear leader in the rally to all time highs in the U.S. stock market. Right now I’d be looking at bank stocks where management is demonstrating a commitment to taking care of shareholders with higher dividend payouts.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
A strong earnings surprise from Citigroup (C) this morning has lifted the banking sector—well, except for Wells Fargo (WFC) and US Bancorp (USB). Citigroup reported third quarter earnings of $1.06 a share, 7 cents a share better than the Wall Street consensus. Revenue climbed just 3% year over year but at $19.41 billion still very handily beat the Wall Street consensus of $18.78 billion.
As of 2 p.m. New York time shares of Citigroup were up 4%. Shares of JPMorgan Chase (JPM) were up 1.71%. Shares of PNC Financial (PNC) and Bank of America (BAC), which report tomorrow and Wednesday, were up 0.46% and 2.52%, respectively. Wells Fargo was down 1.58% and US Bancorp, which reports Wednesday, was off 0.99%. (US Bancorp is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
Unlike Wells Fargo and JPMorgan that last week that said they thought the mortgage and housing markets had turned a corner, Citigroup was much more reserved with Chief Financial Officer John Gerspach saying that the housing market, despite signs of stabilization, still had significant challenges to face. “I don’t use phrases like ‘turn the corner,’” he added.
Instead Citigroup’s story this quarter had much more in common with the bank’s reports in previous quarters. Read more
Moody’s not so astonishing call: Every Spanish bank except Santander (SAN) is at least as risky as the Spanish government
Some of this seems inevitable and reasonable: Today Moody’s Investors Service downgraded the credit ratings on 28 Spanish banks. On June 13 the company cut its rating on the Spanish government to Baa3 from A3. In today’s downgrade Moody’s moved every Spanish bank except Banco Santander (SAN) to a rating lower than that of the Spanish government. Banco Santander’s rating was cut to Baa2 from A3, which leaves the bank one notch above the Baa3 rating on the Spanish government. (In Moody’s system Baa2 is one grade above Baa3. Baa3 is one notch above a speculative or junk rating of Ba1.)
Cutting the credit rating of most Spanish banks after cutting the rating of Spain itself makes sense to me because Spanish banks in aggregate have been the biggest buyers of Spanish government debt at recent auctions. The banks have used money from the European Central Bank’s three-year loan facility to buy government debt that according to European bank regulations counts as risk free capital. In keeping its rating for Banco Santander, a member of my Dividend Income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/, above the Baa3 rating for Spain, Moody’s cited Banco Santander’s manageable level of exposure to Spanish government debt relative to the bank’s Tier 1 capital and the geographical diversity of the bank’s balance sheet.
To put today’s Moody’s ratings in the context of last week’s credit downgrades on global investment banks, the new ratings put Banco Santander in the same Baa2 credit rating group as Citigroup (C) and Bank of America (BAC). According to Moody’s, the government of Spain is now a riskier credit than those two U.S. banks.
This isn’t good news for global financial markets tomorrow.
After the close in New York today JPMorgan Chase (JMP) announced that it had lost about $2 billion on synthetic credit securities (derivatives) in its chief investment office. “This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed,” the bank said in a filing with the Securities & Exchange Commission.
The bank’s shares are down 6.6% in afterhours trading.
At JPMorgan Chase the chief investment office is a unit that makes bets—often very speculative bets—with the bank’s own money. Synthetic credit securities are derivatives that are tied to the credit performance of individual companies. They were supposed to hedge against the bank’s own credit exposure. “In hindsight the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored, said JPMorgan Chase CEO Jamie Dimon. So far this quarter it looks like offsetting gains from the bank’s credit portfolio have resulted in a net loss of $800 million after taxes. The loss could widen or narrow in the rest of the quarter.