Bank Of America: Giving Regulators The Finger

| About: Bank of (BAC)


Bank of America's revised capital return plan is very strong.

The bank is keeping the nickel dividend and a reduced buyback.

This sends a strong signal to investors that internal controls are strong and that management believes in the bank's ability to continue strong earnings.

Bank of America (NYSE:BAC) shareholders have certainly had a rough go of it since the bank's capital plan was withdrawn earlier this year. The plan, which contained a request for a nickel per quarter dividend and a modest buyback, was withdrawn after a miscalculation pertaining to capital ratios stemming from complex securities inherited in the Merrill Lynch buyout. In the aftermath, I argued that the miscalculation was being blown out of proportion and that the withdrawal of the capital plan would eventually be just a hiccup. As it turns out, that's where we find ourselves with today's news.

BAC has apparently requested the same nickel dividend it did earlier this year and a smaller buyback of shares. BAC faithful knew the plan would come back strong and it has but how it has come back is also important. BAC had two components to its capital return plan; the dividend and the buyback. Dividends, especially for banks, are the holy grail of returning capital. Don't ask me why this is but the fact is that is how market participants measure the attractiveness of bank shares. BAC's dividend of one penny is basically meaningless and as such, BAC shares have fallen out of favor with income investors since the crisis.

A buyback, which I favor under many circumstances, reduces the share count but is far less tangible of a benefit to shareholders. When your stock pays you in cash you can see the benefit; when the same company instead buys back shares you assume EPS has been increased but you can't see it directly. As such, the benefits are somewhat difficult to quantify for individual investors. I can appreciate this but I still think it's a shortsighted way to look at things. However, I believe I am in the minority with this view.

That is why I think it's even more important that the composition of BAC's revised request be examined. The two pieces of the request, the dividend increase and the buyback, were both open for reduction this time around. BAC has a limited amount of capital it can return and can thus allocate that capital any way it likes between the two capital return methods. However, choosing to keep the dividend is a strong signal to investors, in my view.

The reasoning is simple; dividends are better received by most investors and dividends are very difficult to cut. Neither of those things are true about buybacks and I believe that is why BAC made the choice that it did and further, I think it was unequivocally the right choice. The same strong dividend increase is sending a message to investors that BAC management believes earnings will be strong in the future and that a dividend is no problem to continue to cover. Reducing the dividend but keeping the buyback would have been a red flag for investors as the variable nature of a buyback program, and the ease with which it can be cut or dissolved, would mean the bank was taking the easy way out with capital returns in case things got dicey again. However, that is not the case and we see BAC has come back with a strong capital return plan not unlike the first one.

The important thing to note about the new plan is that BAC is signaling to shareholders that it is able to forecast earnings with enough certainty to commit to a much larger dividend and that, despite the extra cost, can still cover the buyback. I believe BAC wants to return more capital than it is being allowed and as a result, 2015's return should be a strong increase from this year's number. Overall, though, I am happy, though unsurprised, that BAC came back with such a strong capital return plan and I applaud management for it. The vote of confidence from Moynihan means that BAC shares have but one more hurdle; the extraordinary extortion that is still pending from our nation's government.

Disclosure: The author is long BAC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.