The Federal Reserve announced on December 18th the results of their 2020 mid-cycle stress test of the major U.S. banks. Due to the satisfactory results the Fed will allow the banks to resume share buybacks with some restrictions. The total of dividends and share buybacks can’t exceed the average of the bank’s last four quarters net income.
These guidelines clearly favor the more profitable banks (e.g., J.P. Morgan). Most of the major banks announced plans for share buybacks following the Fed’s announcement. These share buybacks will not begin until Q1 2021 and are expected to be approximately $10 billion in aggregate for the major banks. The Swiss regulators have also eased restrictions on buybacks and both UBS and Credit Suisse announced resumption of buybacks in January 2021. UBS announced a reserve that will reduce their CET1 ratio by 50 bps.
Why are the banks so keen on resuming buybacks? The conventional explanation is that profitability is expressed in terms of return on capital. Excess capital is a drag on returns. That said the major banks return on tangible common equity (ROTE) took a big gap up in the last quarter despite their excess capital. The other reason the banks want to resume buybacks is boosting their stock price and pleasing investors (which include the CEOs of the major banks).
The Takeaway: Any impact on the U.S. banks’ CET1 capital ratios will not be available until the release of the Q1 2021 earnings in mid-April. The annual U.S. bank stress tests (CCAR and DFAST) are scheduled to start around the same time. Depending on the results there could be further easing on the buyback/dividend restrictions. The potential risk here is that banks are starting to resume share buybacks, which will reduce their capital buffers, when there is still uncertainty about the continuing pandemic-driven economic downturn. The Fed is hedging their bets by linking buybacks and dividends to profitability. They might have played it safer by deferring this buyback decision until the annual stress test results in mid-2021. Banks having excess capital during these uncertain economic times in not such a bad thing.