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Banks Will Have To Buy Slightly Less Stock, Which They're Not Very Good At Anyway

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One way to characterize US regulators' new leverage ratio rules is that they require big banks to raise some $80-odd billion of capital, but that's perhaps more alarmist than necessary. The banks don't have to raise that money in the sense of going out and selling $80bn of stock or whatever. They make money every year, and all they have to do is hang on to a little of it (and not lose money!). DealBook quotes Goldman bank analyst Richard Ramsden saying "I am surprised by the [meh-to-positive] market reaction. It’s a fairly demanding proposal,” but Ramsden's note today1 says:

While we estimate up to a $66bn capital shortfall today, this is mitigated by 1) prospects for changes in asset calculations in the final rule, 2) potential asset optimization strategies by the banks if not, and 3) a phase-in period through 2018 (with ~$80bn of aggregate annual net earnings).

Even ignoring the potential rule changes and "asset optimization," $80bn of annual earnings over 5 years = $400bn, of which $66bn, give or take, or 17%, needs to go to increasing capital. You can pay out the rest. It's not that demanding. We're not savages here: nobody's gonna make you raise equity. It's just a question of how fast you can return equity to shareholders.

Coincidentally today the New York Fed has a blog post about banks' share repurchases during the financial crisis. The point here is basically that while, yes, banks were embarrassingly continuing their dividends throughout 2008 while also requiring bailouts, more or less funneling money directly from TARP to shareholders,2 they dramatically reduced their share buybacks starting in late 2007, so at least they were funneling less money to shareholders, so yay:

As the Fed researcher notes, dividends are harder to turn off than share repurchases, so while banks do keep paying out dividends to shareholders even when they can't quite afford to, they're quicker about shutting down share repurchases.3

It's a cliché I know but I can't help but compare that chart to this one, of the XLF Financial Sector ETF:

The fit is pretty good, no? Obviously: bank stock prices hit their peak in the first half of 2007. Bank share repurchases hit their peak in the first half of 2007. Share prices hit bottom in the first half of 2009. Share repurchases in the first half of 2009 were approximately zero. (Share issuances, on the other hand!) Buy high, sell low, as the banks always say.

We've talked before about how bank shareholders like capital return because a dollar in shareholders' hands is worth about a dollar, while a dollar in the hands of the likes of Citi is worth rather less than that. This might be somewhat mitigated by the inefficiency of the mechanism for getting that dollar into shareholders' hands, though: it tends to be done by buying stock, and by buying more stock at higher prices and less stock at lower prices. Raising capital requirements during a recovery - and so reducing share buybacks on the way up - seems positively shareholder-friendly in this light.

I seem to be more skeptical than some people of the view that raising bank capital requirements is entirely costless, but it's nonetheless important to remember that this is hogwash:4

Industry representatives said the proposal could hurt the broader economy by requiring banks to hold more cash in their coffers to meet regulators' demands rather than making loans. ... "Ever-higher capital requirements, while a critically important element of safety and soundness, can become prohibitive and actually lead to reduced capability to lend," said Rob Nichols, president of the Financial Services Forum, which represents the chief executives of the nation's largest financial firms.

Ever-higher capital requirements may reduce lending, as a second-order effect, but their primary effect is to stop banks from using more than 83% of their earnings to buy back stock. Which they're perfectly terrible at! Really it's a win-win.

Regulators Seek Stiffer Bank Rules on Capital [DealBook]
Common Stock Repurchases during the Financial Crisis [Liberty Street Economics]

1.Goldman Sachs Equity Research, "Leverage Ratio Take 2: who is exposed, as proposed," July 10, 2013.


Many analysts and researchers have noted that large BHCs did not reduce common stock dividends until the financial crisis was well under way. For instance, in a study examining capital at large U.S. and European banks, securities firms, and U.S. government-sponsored enterprises, Acharya, Gujral, Kulkarni, and Shin show that dividends at these firms did not decrease significantly until early 2009. In an October 2008 New York Times op-ed piece, Scharfstein and Stein argued that dividend payments by the largest U.S. BHCs would “redirect more than $25 billion of the $125 billion [in TARP capital] to shareholders in the next year alone.” Both sets of authors argued that continued high dividend payments undercut the capitalization of the U.S. banking industry during a time of stress.

3.That is:

Dividends are publicly visible actions requiring regular authorization by a firm’s board of directors. In the banking industry, large BHCs typically declare dividends quarterly and announced them publicly in press releases. In contrast, for all firms, stock repurchases are much less transparent. Firms have the ability to select the timing and amount of repurchases flexibly over time, subject to the details of their repurchase programs. ... In contrast, dividends tend to be interpreted as signals of long-term profitability, decreasing only when profits seem likely to fall to a lower level for a sustained period of time.

4.Oh that's a bit strong! Hogwash-ish. I know, you de-lever by chopping assets rather than building equity, whatever.


Citi Will Try The Stress Test Again With A $9bn Stock Buyback

More stress tests, bleargh. I guess the news is that Citi "failed", though I can't get all that excited by that because it didn't exactly "fail" in the sense of now it's being forced to raise capital / broken up / burned to the ground. Instead it failed assuming it follows the capital plan it submitted to the Fed, which is clearly a capital-lowering rather than capital-raising plan. I ballpark it at $10bn of share repurchases and dividends,* which is ... well, it's pretty big for Citi. So they can just not do that then. Or not do quite as much of that, which seems to be their plan: In light of the Federal Reserve’s actions, Citi will submit a revised Capital Plan to the Federal Reserve later this year, as required by the applicable regulations. The Federal Reserve advised Citi that it has no objection to our continuing the existing dividend levels on our preferred stock and our common stock, and we plan to do so, subject to approval by the Board of Directors each quarter. The Federal Reserve also advised that it has no objection to Citi redeeming certain series of outstanding trust preferred securities, as Citi proposed in its Capital Plan. We plan to engage further with the Federal Reserve to understand their new stress loss models. We strongly encourage the public release of these models and the associated benchmarks and assumptions. We believe greater transparency in this process will best serve all banking institutions and their shareholders as well as the international regulatory community and market participants, and will encourage a level playing field globally. There are at least two ha! moments in that snotty last paragraph. First there's the fact that the Fed had planned to release the stress test results on Thursday and got gun-jumped by Jamie Dimon. So much for Fed transparency. But also, specifically, as people are all running around suing each other about the Fed maybe kind of encouraging bank CEOs to hide material information from investors, it is odd that the Fed would have the stress test results and sit on them for two days. Imagine the scenario where Jamie Dimon, Vikram Pandit, and the Fed all know that JPM passed and was going to do a largeish buyback, while Citi failed and was going to do a ... I guess somewhat smaller buyback - and they didn't tell anyone from today until Thursday. If you sold JPM to buy C today, wouldn't you be kind of annoyed?**