Some Banks Dilute Shareholders, Despite Buybacks

NEW YORK (TheStreet) -- The second part of the Federal Reserve's annual stress tests on big banks will be concluded this week, with most of the big banks ready to announce large share buybacks, but some of these banks made only small net reductions in their share counts last year, and some actually diluted common shareholders.

This means investors shouldn't be basing their decisions on the buybacks, but should take a closer look at what the announced amounts actually mean, while also looking at net buybacks for previous years, to factor in stock issuance for employee awards.

This is the annual "gravy week" for U.S. bank stock investors. The Fed last Thursday announced the results of the Dodd-Frank Act Stress Tests (DFAST) on 30 large holding companies, with all but Zions Bancorporation (ZION) of Salt Lake City showing they could remain well-capitalized, with Tier 1 common ratios of at least 5.0% through a nine-quarter "severely adverse" economic scenario.

On Wednesday the Fed will announce the results of the second part of the stress tests, called the Comprehensive Capital Analysis and Review (CCAR), which incorporates the banks' annual plans to deploy excess capital through dividends, share buybacks and/or acquisitions, into the same severely adverse scenario.

Last year the Fed only objected to the capital plan submitted by one bank -- BB&T (BBT) of Winston-Salem, NC. The regulator also gave conditional approval to the capital-return plans of JPMorgan Chase (JPM) and Goldman Sachs (GS), with both companies allowed to go ahead and begin deploying excess capital, but also being required to submit updated capital plans which were accepted by the Federal Reserve in August.

Investors of course love dividend increases, but the Federal Reserve over the past several years has been limiting large banks' dividend payouts to roughly 30% of earnings. So share buybacks are the key component of the capital plans. Buybacks can be a wonderful thing, if they are large enough to lower the share count significantly. All things being equal, net buybacks raise earnings-per-share, lead to increased EPS analysts from analysts and support higher share prices.

But what if the buybacks aren't large enough to reduce the share count significantly? Banks may be forced to change their plans, as JPMorgan Chase did over the past two years. The company in May 2012 suspended its buybacks for that year after it discovered the "London Whale" hedge trading problem, which led to over $6 billion in pretax losses. The bank didn't follow through with its entire plan to repurchase shares last year either, when booked a third-quarter net loss as it set aside sufficient litigation reserves to absorb most of $17.5 billion in residential mortgage -backed securities settlements in the fourth quarter.

JPM was approved by the Fed last March to repurchase up to $6 billion in common shares from second-quarter of 2013 through the first quarter of 2014, but only bought back $3.928 in shares, according to an estimate from KBW.

Factoring in estimated share issuances, including those for employee stock-bonus awards, JPMorgan's net common-share buybacks from the second quarter of 2013 though the first quarter of 2014 have totaled $1.76 billion.

According to JPMorgan's annual report, the company's year-end count of common shares declined 1.3% during 2013 to 3.756 billion as of Dec. 31. But during 2012, the bank's year-end share count rose 0.8% to 3.804 billion.

KBW analyst Christopher Mutascio estimates JPMorgan on Wednesday will receive approval from the Fed for gross share repurchases of $7.260 billion from the second quarter of 2014 through the first quarter of 2015. Mutascio also estimates JPMorgan's net repurchases for that period will total $6.330 billion.

Bank of America's (BAC) common-share count declined by 1.7% during 2013 to 10.592 billion as of Dec. 31, but the share count rose in 2012 by 2.3%. The company was able to complete its planned $5 billion in gross share repurchases following last year's CCAR, with its net repurchases totaling $3.514 billion from the second quarter of 2013 through the first quarter of 2014, according to KBW's estimate.

Mutascio estimates Bank of America will receive approval this week for $7.2 billion in common-share buybacks from the second quarter of 2014 through the first quarter of 2015, with an estimated $6.060 in net buybacks over that period.

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