Investors in bank stocks and the related exchange traded funds (ETFs) good some good news last week from the Federal Reserve and no, it did not concern interest rates.
The central bank released highly anticipated results of its Comprehensive Capital Analysis and Review, or CCAR.
CCAR “evaluated the capital planning processes and capital adequacy of 18 of the largest banking firms, including the firms' planned capital actions, such as dividend payments and share buybacks,” said the Federal Reserve . “Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.”
In terms all of us can understand, the most recent CCAR results are good news for ETFs, such as the Invesco KBW Bank ETF (KBWB ), because the major U.S. banks look, in the eyes of the Fed, sturdy enough to continue repurchasing their own shares and boosting dividends.
KBWB tracks the KBW Nasdaq Bank Index and as the fund and index names imply, the products are dedicated to bank stocks, unlike diversified financial services, which usually future exposure to capital markets firms and insurance providers.
As of June 28, KBWB had a trailing 12-month distribution rate of 2.52 percent, according to issuer data . That is better than the dividend yield on the S&P 500, but also low enough to imply there is a significant runway for dividend growth among the fund's 24 components.
Several marquee KBWB holdings, including Bank of America (BAC), JPMorgan Chase & Co. (JPM) and US Bancorp (USB) , are expected to have higher payout ratios this year than they did following the 2018 CCAR, meaning dividends are growing.
“Estimated median payout ratios are projected to be approximately 120% for the 12 U.S. banks that publicly disclosed their capital plans for the next four quarters, based on annualized 1Q19 net income,” said Fitch Ratings . “This is up substantially from around 80% in last year's CCAR process.”
Adding to the case for higher dividends is the expected increase in buybacks. Banks reducing their shares outstanding tallies via repurchase programs also lower their dividend expenses by retiring shares.
“For the 12 Fitch-rated banks, buybacks were 75% of the roughly $175 billion collective capital request, which can be toggled down if needed,” according to Fitch.
As two prime examples of the big bank big buyback trend, Bank of America and JPMorgan Chase, two stocks that combine for almost 16 percent of KBWB's weight, are expected to repurchase $30.9 billion and $29.9 billion, respectively, of their own shares. In both cases, those figures exceed estimates calling for buybacks of $22 billion to $25 billion .
“Requested dividend payouts increased by 13.4% from last year, down from the 21.5% requested increase in 2018,” said Fitch. “Bank of America had the highest increase at just under 50%.”
Sturdy Balance Sheets
Eighteen banks applied for various capital plans under the CCAR and the Fed approved of 17. Of course, that means banks are shoring up capital provisions to prepare for market crisis. In fact, it was the global financial crisis that spawned the CCAR and banks, including KBWB holdings, have bolstered capital positions since then.
“The firms in the test have significantly increased their capital since the first round of stress tests in 2009,” said the Fed. “In particular, the largest and most complex banks have more than doubled their common equity capital from around $300 billion to roughly $800 billion during that time.”
Data suggest major financial services firms have already been voracious buyers of their own shares. In the first quarter, S&P 500 financial members bought back $42.84 billion of their own stock, bringing the total for the 12 months ending March 2019 to $159 billion, according to S&P Dow Jones.