The results of the capital plans of the Federal Reserve's Comprehensive Capital Analysis and Review were released Thursday afternoon amid great speculation as to what the results might tell us about our nation's largest banks. Bank of America (BAC) has come out a huge winner, in my view. The bank asked the Fed for $5 billion in common stock buybacks and $5.5 billion in preferred share redemptions for 2013. This request was granted and has several implications.
First, it proves BAC is clearly out of the damage control mode that ensued following the horrific aftermath of the financial crisis which saw shares eventually trade down to $5. If BAC didn't have a fortress capital position, the Fed would not have allowed any capital returns, let alone over $10 billion worth. Second, BAC will be repurchasing common shares that are trading below their tangible book value. With tangible book in the $13 to $14 range and shares trading for just over $12, this will be money well-spent. Third, the company is going to retire $5.5 billion worth of preferred debt that is yielding over 8%. This move alone will save BAC $450 million annually in interest expense.
The point is that BAC has officially moved on from the financial crisis and is preparing for the future. I was wrong when I predicted BAC would raise its dividend Thursday instead of initiating share buybacks. I thought BAC would raise the dividend because it is the "safe" choice. However, BAC has done the right thing instead with its capital plan in building for the future. BAC will be able to retire 450 million shares (assuming today's prices) this year and that is great for the long term holders of the stock. We can now ratchet up BAC's estimated EPS growth numbers for the next couple of years based on $450 million in reduced interest expense from the preferred share redemptions and 450 million less common stock shares that will be repurchased.
I was a BAC bull before Thursday's announcement when I thought a dividend raise was coming, but I couldn't be happier with what BAC requested from the Fed. Not only will the float be reduced, ratcheting up EPS in the coming years, but BAC is retiring debt that is costing it over 8% per year in dividend payments. BAC has more than enough capital to not need that money but if management decides to replace it, the bank can borrow the money back much more cheaply than what it is paying on the preferreds. However, given declining loan-to-deposit ratios, I'd say BAC has more than enough money to lend out without refinancing the preferreds it is retiring. Bank of America shareholders received a gift today and I am more of a bull than ever now that I know management has shareholders in mind when it makes capital decisions. BAC is now set up very nicely for EPS growth in the future as management has set the bank up to profoundly decrease interest expense and the amount of shares that will be outstanding at the end of this year.
Disclosure: I am long BAC.