By Telis Demos and Peter Rudegeair
The six biggest U.S. banks could potentially return more than $100 billion in capital to investors over time through dividends and share buybacks if the Trump administration succeeds in a push to loosen bank regulation.
President Donald Trump on Friday signed a memorandum ordering a review of the Dodd-Frank Act, the postfinancial-crisis regulatory overhaul that has guided regulators such as the Federal Reserve. The aim is "cutting a lot out" of those rules, President Trump said in a meeting at the White House.
That caused bank stocks to gain ground Friday, building on sharp increases since the presidential election. Those occurred as investor expectations of higher interest rates, less regulation and stronger economic growth stoked optimism.
Big banks such as J.P. Morgan Chase & Co. and Citigroup Inc. climbed more than 3%, while the KBW Nasdaq Bank Index gained about 2.2%. That index has risen about 24% since Election Day compared with a 7.4% gain for the S&P 500.
"Bank regulation didn't seem like priority one for the administration, so to see these executive actions come so early is a positive," said Jason Benowitz, senior portfolio manager at the Roosevelt Investment Group Inc., which manages $3 billion.
As much as shareholders would welcome greater capital returns in the short term, though, such a move would entail risks. Before the financial crisis, for example, it was common for large banks to spend more on dividends and stock repurchases than they earned in annual profit. That left big banks including Citigroup poorly positioned for financial tumult, leading it and others to be bailed out by the government.
It isn't clear exactly what regulatory measures Mr. Trump's push could eliminate. But one area investors are looking at is billions of dollars of capital that banks have been forced to hold as a buffer against future financial crises.
Bankers have argued that those buffers are in excess of what they need to absorb losses. And some investors have come to regard this as trapped capital since the banks' ability to return funds to shareholders is restricted by the Fed through annual "stress tests." That has led many lenders to hold more capital.
The top six U.S. banks have $101.57 billion in capital in excess of what regulators require them to set aside, according to research from RBC Capital Markets. Analysts at Morgan Stanley estimate such capital at around $120 billion across 18 of the largest banks.
Citigroup has the most excess capital at around $27 billion, according to RBC., J.P. Morgan has $20 billion, and Wells Fargo & Co. has $16 billion.
"Regulatory relief could be a significant tailwind for the industry in terms of capital efficiency and managing cost," said Conor Muldoon, fundamental portfolio manager at Causeway Capital Management LLC, which manages $44 billion globally. Citigroup is the largest holding in the firm's Global Value fund, which invests across sectors. The potential for it to return capital is a key reason for the investment, Mr. Muldoon said.
Being able to release more or all of that capital would be a boon to banks and their investors in several ways. First, banks would likely return much of the capital through dividend increases orhigher share buybacks. The latter, by decreasing the number of shares a bank has outstanding, helps to boost earnings per share. That, in turn, can boost share prices.
Goldman Sachs bank analysts said the average, big U.S. bank could boost 2018 earnings per share by 13% if all excess capital is returned to shareholders via buybacks.
As well, reducing the amount of capital a bank holds helps to boost returns on equity. This is a measure of bank profitability that compares net income with common shareholder equity.
Many big banks have struggled in recent years to post returns that exceed their theoretical cost of capital -- or how much it costs them to raise funds -- of about 10%. This is due to the superlow-interest-rate environment, slow revenue growth, subdued trading activity and higher capital bases.
If banks' return on equity jumps, that would likely lead to higher valuations for their shares.
Requirements forcapital aren't explicitly laid out in the Dodd-Frank Act, but are set by the Fed and other regulators. They also are guided by international banking agreements.
While the Trump administration couldn't directly change these, it could influence them, as well as the Fed's stress tests, through its appointments to regulatory bodies. Notably, Mr. Trump is expected to appoint a new head of bank supervision for the Fed, a position mandated by Dodd-Frank but which went unfilled by the Obama administration. Meanwhile, Republicans in Congress have urged the Fed to suspend its participation in these global banking discussions.
And the trend was already headed toward greater capital returns. Before the election, the Fed had been forecasting that it would let banks pay out more to investors, and banks including Citigroup have said their aim was for substantially greater return to investors in 2017.
CLSA analyst Mike Mayo in a January reportestimated that the typical bank's payout in the form of dividends and buybacks as a portion of earnings would go to 85% by 2019 from 65% in 2015, with capital returned rising to $110 billion from $70 billion.
But capital returns that are a boon for shareholders could make debt investors nervous, leading to an increase in bank funding costs. Fitch Ratings warned Friday that banks could become riskier with smaller capital buffers.
"Any changes in rules that reduce capital and liquidity requirements could have negative rating implications if banks respond to such rules with weaker capital and liquidity positions," said Joo-Yung Lee, head of North American financial institutions for Fitch.
(END) Dow Jones Newswires
February 05, 2017 14:26 ET (19:26 GMT)
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