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.

Along with JPMorgan and Bank of America, KBW in a note to clients Sunday lumped Wells Fargo (WFC) and Goldman Sachs (GS) into the group of stress-tested banks with "least effective" share buyback programs last year. Wells Fargo's gross share repurchases totaled $6.682 billion from the second quarter of 2013 through the first quarter of 2014, according to KBW's estimate, but its net repurchases only came to $1.379 billion. Goldman's gross repurchases totaled an estimated $5.858 billion over the same period, with net repurchases of $2.896 billion. Wells Fargo's period-end share count was flat last year, while Goldman's period-end common-share count by 2.7% to 467.4 million shares as of Dec. 31.

Citigroup's C period-end share count was flat in 2013, at 3.029 billion as of Dec 31, but the company's share count rose 3.6% during 2012. The company was approved for $1.2 billion in buybacks following the March 2013 stress tests. On Wednesday, KBW analyst Fred Cannon estimates Citi will receive Federal Reserve approval for $7.619 billion from the second quarter of 2014 through the first quarter of 2015, with net repurchases for the same amount.

The stress-tested bank showing the most common-share dilution during 2013 was M&T Bank (MTB) of Birmingham, Ala., with period-end shares rising 1.8% year-over-year to 130.6 million as of Dec. 31. The company is not expected to request approval for any buybacks from the second quarter of 2014 through the first quarter of 2015, because it is working to improve its Bank Secrecy Act and anti-money laundering compliance, in preparation for its long-delayed acquisition of Hudson City Bancorp (HCBK) of Paramus, N.J.

A larger regional bank showing some dilution last year was PNC Financial Services Group (PNC) of Pittsburgh, with period-end common shares outstanding rising by 1% to 533 million as of Dec. 31. Mutascio estimates PNC will receive approval on Wednesday for $972 million in buybacks from the second quarter of 2014 through the first quarter of 2015, with net buybacks of $729 million.

Largest Share-count Reductions

Among the big U.S. banks subject to the stress tests and CCAR, the two seeing the largest share-count reductions during 2013 were State Street (STT) of Boston and Discover Financial Services (DFS). Both companies made sufficient net share repurchases to reduce their share counts by more than 5% during 2013, after doing the same during 2012.

KBW analyst Robert Lee estimates State Street on Wednesday will receive regulatory approval for $2.026 billion in common-share buybacks from the second quarter of 2014 through the first quarter of 2015, with estimated net buybacks of $1.620 billion, down slightly from estimated net buybacks of $1.676 billion from the second quarter of 2013 through the first quarter of 2014.

KBW analyst Sanjay Sakhrani estimates Discover will be approved for $1.6 billion in buybacks from the second quarter of 2014 through the first quarter of 2015, with estimated net buybacks of $1.365 billion, increasing from estimated net buybacks of $1.256 billion for the prior-year period.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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