By Robert Gordon
Just recently the Federal Reserve released the results of its third, and most recent, Comprehensive Capital Analysis and Review, otherwise known as the "stress test." Perhaps as a dig at Federal Reserve Chair Ben Bernanke, Jamie Dimon and JPMorgan Chase (JPM) somehow found out about the stress test results two days earlier, and acted on that by announcing a dividend hike and share buyback.
The stress test involved 19 bank and bank holding companies, which together comprise roughly 65% of bank held assets in the United States. Five of these are relative newcomers to the bank world, only having been chartered in 2008 in order to obtain federal bailout loans under the Troubled Assets Relief Program, or "TARP. " The main four are American Express (AXP), Goldman Sachs Group (GS), Morgan Stanley (MS) and MetLife (MET). The fifth company, Ally Financial, is privately held with the U.S. government being by far the largest shareholder. Ally is the former General Motors Acceptance Corporation (GMAC).
The stress test posited what would happen to banks' financial health if unemployment rose to 13%, real estate prices fell by 20%, and equity prices fell by 50%. All but four of the 19 banks passed the stress test, the bottom line of which was whether Tier One, risk adjusted common capital would remain above 5%. A complete result of the stress test is found here.
Perhaps the most impressive performer in the report is American Express. Only the two trust banks, Bank of New York Mellon (BK) and State Street (STT) reported higher actual or proposed "after meltdown" capital levels. Even after all the hypothetical drastic economic news suggested by the Fed occurred, American Express' primary capital measure would be 12.4%, or 250% of the minimum standard. American Express has announced capital plans of a dividend hike and common share buyback, which after implementation would drive that capital level down to 10.8%, or still nearly 220% of the 5% required.
So, the Fed believes American Express has plenty of ability to return capital to shareholders. I am not so sure. I detest when companies buy back their own shares because it has nothing better to do with their money. American Express announced it would be raising the dividend by 11%, to 20 cents quarterly, giving it a yield of 1.4% It also announced a $5 billion share buyback. American Express stock is now trading for over three times its book value. I think another major share buyback is a foolish move. American Express has retired over 200 million shares of its stock in the last 10 years. It also has averaged a roughly 23% annual return on shareholders' equity during that time frame. I have owned shares of American Express in large part because I believed in the company's ability to make a good return on my invested dollars - a better return than what is available in other risk adjusted alternatives. I believe there are better uses for $5 billion than buying more stock (hint, debt is 69% of capitalization).
In 2011, American Express reported record profits of $4.93 billion, or a record $4.08 per share. It did this the old fashioned way; by growing revenues. 2011 revenues were up about $2.2 billion on a year over basis, to $29.96 billion. It kept its expenses in check enough to report ever expanding profit margins; 16.5%, up 190 basis points from the 14.6% posted in 2010. Cards outstanding and amounts spent per card are both at all-time highs. Best of all, the company's tight underwriting ensures minimal delinquencies and charge offs. Consult the chart here for more detail on that.
American Express recently saw an all time high stock price of $66 per share. I would be disappointed were it not to hit that level or beyond in the next 12 to 18 months.
Other big winners in the stress test were money center banks J.P. Morgan and Wells Fargo (WFC). JPMorgan's management has tossed around the phrase "fortress balance sheet" often in recent years. Well, maybe they have been overstating it. With no dividend hikes or stock buybacks, the Fed estimates JPMorgan's Common Capital ratio after the hypothetical economic meltdown would be at 6.3%, at least a full percentage point behind the healthy group of regional banks such as PNC Financial (PNC) and Fifth Third Bancorp (FITB). And after taking the capital actions described below, JPMorgan's common ratio would be only 5.4%. A passing score, but hardly a fortress. One might think one of the 29 Banks Too Big to Fail and subject to Basel III standards might want to address increasing reserves and equity. Instead, JPMorgan announced a 20% dividend hike up to an annual $1.20, for a current yield of 2.7%, and another $12 to $15 billion stock buyback. That would not be too bad if it were not for the fact that JPMorgan stock is selling well in excess of the company's $31 per share tangible book value.
Wells Fargo also wasted no time in increasing its return of capital to shareholders. The Fed determined that if its worst case economic scenario played out, and Wells Fargo returned capital to shareholders, its key common ratio would remain at 6%. In response, Wells Fargo nearly doubled its dividend to a quarterly $0.22 per share, for an annual yield of 2.6%. Wells Fargo did not announce a stock buyback, though it had such a program in place in 2011, and I would be surprised if a modest buyback program were not announced fairly soon. Wells Fargo earned a return of 1.25% of profits, and its efficiency ratio of 61% will likely be lower this year due to the bank's "Project Compass," designed for $1.5 billion annual expense savings.
Wells Fargo is one of those rare companies and I am not concerned about the price or PEG ratios. It is the premier money center bank in this country. If that is the type of situation you seek, Wells Fargo is the choice. But I like some large regionals and Canadian banks more over the next 12 - 24 months.