US banks just can’t catch a break. Last month Jay Powell, Federal Reserve chairman, reiterated that rock-bottom rates were here to stay. In the process, he dashed hopes of a recovery in lending margins for the sector. Late on Wednesday, the US central bank delivered another piece of bad news: it will extend the freeze on share buybacks and capped dividend payouts by big banks until the end of the year. The former matters most.
Under the curbs introduced in June, a bank’s dividend cannot be higher than either the previous year’s payout or average quarterly earnings for the previous four quarters. Wells Fargo became the first to buckle this summer when it slashed its dividend from $0.51 to $0.10 a share. Unlike other bulge-bracket banks, it lacks sizeable trading or investment banking operations to offset the weakness in its retail banking.
Ultra-low borrowing costs have not brought only bad news for banks. The resurgence in mergers and acquisitions activity, along with a boom in refinancing and debt and equity offerings, are driving a fee bonanza. Global investment banking fees for the first nine months of 2020 totalled $89.7bn, a new record for the period, according to Refinitiv. Market volatility during the third quarter may well boost trading revenues.
Nevertheless, banks remain unloved. The S&P 500 Bank index is down more than a third this year and trades at a steep discount to the S&P 500 on a price-to-forward-earnings basis.
Rising loan-loss reserves and falling profits do not help. But perspective is important. Despite setting aside tens of billions of dollars for potential bad loans, the six biggest Wall Street banks still made almost $13bn in profit during the second quarter. Big banks are in better shape to ride out the economic downturn than investors may think. Money put aside in reserves could well end up not being used, enhancing earnings later.
In recent years, US banks have provided most of their shareholder returns via stock repurchases rather than through dividends. The Fed’s ban on share repurchases will not last for ever. Investors should position themselves for the eventual upturn.
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