Less than a year ago, the US Federal Reserve wrote big banks may “use capital distributions to signal financial strength, even when facing a deteriorating or highly stressful environment”. Little did the central bank anticipate such a quick test of that hypothesis.
Since the last financial crisis, the biggest financial institutions have been forced to add hundreds of billions of dollars in equity to their balance sheets to boost loss-absorption capabilities. By 2019, the group felt its investors had swallowed all of their bitter medicine. The consequence was that the likes of JPMorgan, Citigroup, Bank of America and others got the green light to distribute more than 100 per of net income to shareholders using dividends and buybacks.
Accepting the new economic reality this year, banks in March announced plans to halt share repurchases. However, they have hesitated to abolish dividends. Dividends are not large relative to the size of their balance sheets. But given risk aversion, and a sensitivity to public perception, halting these quarterly payouts would be wise.
Large US banks prefer to return capital to shareholders using buybacks. These can boost earning per share by reducing a company’s share count and offer a better tax treatment for investors. In 2019, the proportion of buybacks to total shareholder returns for JPMorgan, Citigroup and Bank of America was between two-thirds and four-fifths. The three ended the year with $650bn of common equity while the sum total of their dividends was just $24bn.
Retaining those $24bn of dividends instead as equity, for banks still levered 10:1, looks sensible. JPMorgan’s Jamie Dimon, who loves to boast of his bank’s “fortress balance sheet” even on Monday said the bank would consider halting its dividend if the economy was heading for a worst-case scenario.
The good news for shareholders is that leverage can work both ways. When the economy begins to recover, banks should benefit first. Regulators may still be risk averse about immediately allowing big dividends and buybacks. But bank investors will be repaid in appreciating market values nonetheless.
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