July 29th, the Federal Reserve announced the results of the CCAR process including the requested capital return actions for the big banks.
Unsurprisingly to those that have been reading this newsletter, the results were very good and we have seen an influx of dramatic dividend increases and stock buybacks.
Below I’ll outline a few of the key ones for investors of T&T Capital Management (TTCM) and what it means for us as shareholders.
- Citigroup (C)
- More than tripled its quarterly dividend from 5 cents to 16 cents.
- At a recent price of $42.39, this equates to a 1.5% yield, which is right around where the 10-year Treasury yield is.
- More importantly I’d argue, Citigroup is also buying back $8.6 billion of its own stock. This buyback is equivalent to about 7% of the current market capitalization of $124 billion.
- With the stock trading at such a massive discount to tangible book value, this will be enormously accretive.
- It seems very likely that Citigroup should be able to increase its tangible book value per share of $62.07 by 11-15% after dividends over the next year through the retention of earnings and the accretive nature of the buybacks.
- Realistically, Citigroup could have returned double or triple this amount of capital and still qualified on a quantitative basis with all capital rules, due to its incredibly safe balance sheet.
- Unfortunately, the Fed uses a very bureaucratic and political process where they would likely reject this due to “qualitative” issues.
- It is amazing to think that a company that has never been safer from a balance sheet standpoint could rally by about 50% from current stock prices and would only trade right around its rapidly growing tangible book value.
- The stock’s performance has been terrible this year despite good fundamentals.
- Despite these capital return increases, Citigroup will still be building capital in 2016.
- I wouldn’t expect this to last much longer barring a historically bad recession.
- Bank of America (BAC)
- Announced a plan to buy back $5 billion of stock and raised the dividend by 50% to 7.5 cents a quarter. This equates to a dividend yield of about 2.26% on a recent price of $13.27.
- The stock buyback is pretty conservative at about 3.6% of the current market cap.
- Bank of America will also continue building its capital ratios this year after these capital returns.
- Morgan Stanley (MS)
- Announced a dividend increase to 20 cents a share from 15 cents a share. This equates to a yield of 3.07% on a recent price of $25.98.
- In addition, Morgan Stanley is able to buy back $3.5 billion of stock, which represents about 7.1% of the current market cap.
Our banking industry has never been stronger
These are only a handful of the announcements but suffice it to say our banking industry has never been stronger. Low interest rates are a major negative without a doubt and the slow-growth economy isn’t conducive for dramatic investment banking profits. With that said, there is so much upside in earnings power for these companies.
Eventually we will see 90-100% capital return ratios for these big banks because they are already overly capitalized, yet are far from that type of capital return ratio due to the Fed’s conservatism.
Ultimately, this will result in higher returns on equity as the denominator will finally stop growing faster than the numerator on the ROE equation. Obviously, higher rates and faster economic growth will occur at some time.
Lastly, the valuations of these big banks have never been more absurd relative to intrinsic value. In previous days, we would have seen mergers and these prices would not last. The Fed won’t let the big banks do any more big mergers so that has stalled the arbitrage gap from filling. Also the fact that the capital return process is so controlled prevents these companies from bridging that gap on their own via stock buybacks. At some point the market will appreciate the safety from the fortress balance sheets, sector-leading dividend growth, and unrealized earnings power of these franchises!