Bank Of America Shareholders Deserved More From CCAR

| About: Bank of (BAC)

Summary

BAC finally received a clean pass from CCAR, allowing it to return ~$8bn to its shareholders.

Peers however have much higher payout ratios raising the question of whether BAC should have done more.

Excess quantitative capacity supports the argument that a higher payout from BAC was possible.

This year Bank of America's (NYSE:BAC) capital planning process was a resounding success. Despite facing dire test scenarios including a negative interest rate environment, the $2trn bank by assets past DFAST with substantial quantitative capacity left.

Meanwhile on June 29th, BofA finally made it through CCAR without any conditions or objections from the Federal Reserve. It was an excellent result after three years of stumbling through the process without a clean pass.

BofA rewarded shareholders with a $5bn share repurchase program and a $0.075 per share quarterly dividend.

The repurchase authorization runs from July 1, 2016 to June 30, 2017; four quarters versus last year's five quarters. This implies an increase of over 50% per quarter from last year's repurchase plan. Dividends increased by 50% from last year's $0.05 per share.

Yet, despite these big percentage increases, BofA came in below the capital return plans of its peers.

Comparing capital return plans

Fig. 1 outlines the 2016 capital return plans of the money center banks. As of this writing, Goldman and Wells Fargo haven't announced the details of their plans. Morgan Stanley (NYSE:MS) received a "conditional non-objection" to its plan and must resubmit it by December 29th.

The table displays calculations for the total returns per share of each bank including both dividends and share buybacks (assuming that the repurchase plan was completely exhausted). I calculated the total return per share as a percentage of prior year's earnings per common share (EPS) and as a percentage of the average analyst estimate for 2016 EPS.

Based on these calculations, BofA is providing the lowest payout of all the money center banks at 57% of 2015 EPS and 60% of this year's estimated EPS. A disappointing result when compared with the bank's peers, who averaged a 91% payout ratio on 2016 forward EPS and 81% on 2015 reported EPS. Even when excluding MS, the payout ratio is 81% of 2016 forward EPS and 74% of 2015 EPS.

Fig. 1

Total capital return (in millions)

Share buyback (in millions)

Dividends (in millions)

Shares out. (1Q16 period-end in millions)

Total return per share

Annualized dividend

Market price

Dividend yield

% of EPS one year ago

% of Avg. EPS est.

BAC

$8,082

$5,000

$3,082

10,272

$0.79

$0.30

$12.76

2.35%

57.01%

60.06%

JPM

$17,621

$10,600

$7,021

3,657

$4.82

$1.92

$59.76

3.21%

80.31%

84.98%

C

$10,478

$8,600

$1,878

2,935

$3.57

$0.64

$40.92

1.56%

66.73%

76.78%

MS

$5,050

$3,500

$1,550

1,937

$2.61

$0.80

$25.00

3.20%

96.55%

111.41%

Click to enlarge

Source: SEC filings; Yahoo Finance; and author's calculations

Could Bank of America have asked for more?

It certainly had the quantitative capacity to.

In Fig. 2, we return to BAC's CCAR results. The table below presents a hypothetical scenario where an additional $3bn was added to the company's 2016 capital return plans, making the total ask for the next four quarters ~$11bn. At ~$11bn, BAC's capital returns would be approx. 81% of the company's average forward EPS estimate of $1.31.

As the table shows, if we raised BAC's capital ask by $3bn, the company's capital ratios still remain robust in comparison to its regulatory minimums. Tier 1 leverage, for example, falls to just 5.77% from 5.90%, while BofA's Common equity tier 1 capital ratio falls to 6.9% from 7.1%.

In performing this scenario analysis, we need to recognize the limitations of it. The Fed may very well have a threshold that is higher than the regulatory minimums that they outline, but isn't readily provided to the public. After all, as a regulator, you don't want systemically important financial institutions executing capital plans that would put them right up against the "red line".

In addition, these are back of the envelope calculations and don't reflect the nine quarter projections necessary to accurately predict minimum capital ratios, so readers should adjust their expectations accordingly.

But with at least 177 bps in between the Tier 1 leverage ratio and its regulatory minimum, the smallest gap amongst BofA's capital ratios, the bank does seem to have had the quantitative capacity to have asked for more. And if you consider that any additional requests could have been in the form of stock buybacks, it seems that BAC missed an opportunity to really wow their shareholders this year.

Fig. 2

(all dollars in bn)

Actual (4Q15)

Minimum

Reg. Min

Min. capital

Reg. min. capital

Difference

Additional capital ask

New min.

Common equity tier 1 capital ratio

11.60%

7.10%

4.50%

$108

$69

$40

$3

6.90%

Tier 1 capital ratio

12.90%

8.80%

6.00%

$134

$91

$43

$3

8.60%

Total capital ratio

15.70%

11.90%

8.00%

$181

$122

$59

$3

11.70%

Tier 1 leverage ratio

8.60%

5.90%

4.00%

$134

$91

$43

$3

5.77%

Actual (4Q15)

Proj. (1Q18)

Risk-weighted assets

$1,403

$1,523

Assets*

$2,103

$2,271

Click to enlarge

Source: DFAST and CCAR data from Federal Reserve; author's calculations

*Assets for the 1Q18 were calculated as (134/5.9%)

Speculating on BAC's below average capital return plans

In April, when capital plans were submitted by the banks, the world was a different place. At the time, interest rates were forecasted to rise - one of the most significant catalysts for BAC - by potentially 75 bps for the year. An often over-cited statistic is that BAC's net interest income would increase by ~$6bn if a 100 bps parallel move occurred in the yield curve. Money that would mostly drop to the bottom line, after the IRS takes its cut of course.

Offsetting this yield curve optimism was volatile energy prices and concerns about BAC's exposure to the oil & gas sector. But this was a shared concern for many of the money center banks, so it wouldn't have resulted in the significant difference in capital return plans. Besides the fact that by April, the oil & gas issue was well documented and something that the banks were addressing in their earnings calls.

While it's difficult to know for sure why Bank of America's CCAR submission was so conservative, this analyst tends to think that after three years of coming up short that Mr. Moynihan was just concentrated on getting the submission right.

The reality is the DFAST and CCAR processes are significant tests of management's ability to navigate a more regulated world. Too many failing grades would have likely ended Mr. Moynihan's tenure in the top spot - and rightly so.

In sum

I respect Mr. Moynihan. He has methodically turned around the aircraft carrier that is BofA and these most recent CCAR results are a testament to that turnaround.

But Bank of America had a chance to be bold in this CCAR submission and demonstrate to the shareholder faithful that the company was finally ready to shed the legacy issues of its past and normalize its payouts.

While I can appreciate the bank's conservativeness, I think in this instance that BAC missed an opportunity to really make an impression on shareholders and get the market to start rethinking about the stock. This year's CCAR results were a good start, but it could have been a great one.

Disclosure: I am/we are long BAC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.