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Morningstar | No Big Surprises for 2019 Stress Tests: Money Center Banks Are the Big Winners With Repurchases

Because of last week’s Dodd-Frank Act stress tests, we weren’t expecting any surprises for the Comprehensive Capital Analysis and Review results. Only one bank ran into issues this time around, which was better than the four in 2018. This year, Credit Suisse received a conditional nonobjection, as the Federal Reserve is “requiring the firm to address certain weaknesses in its capital planning processes.” The Fed also noted that Capital One and JPMorgan had to adjust their capital plans, as both banks’ original plans caused multiple regulatory ratios to fall below their required minimums. Even so, each bank submitted an adjusted plan that was approved. Not surprisingly, JPMorgan and Capital One had the lowest stressed common equity Tier 1 ratios, each at 4.6%, with Bank of America next at 5.6%. The average stressed Tier 1 ratio for the 2019 cycle was 6.6% compared with 6.3% for the 2018 cycle.

Capital return approvals largely met our expectations. The money center banks had large repurchase approvals, with three of the four able to repurchase over 10% of their current market caps. We calculate that dividends are set to grow about 15% on average for our banking coverage (of the banks that have reported updated capital plans), while approved share repurchases are set to grow approximately 22%. We calculate that over half of our money center and regional bank coverage will be at or very close to their regulatory capital targets after this CCAR cycle, meaning that most will likely be returning less than 100% of net income going forward (assuming balance sheet growth). We calculate that the current payout ratio for this group is roughly 115%. The biggest exceptions to this are US Bancorp, PNC Financial Services, and M&T Bank, which we calculate could still have more than 25 basis points of excess Tier 1 capital left to release for the 2020 CCAR cycle.

The money center banks had some of the largest approved payout ratios (based on consensus earnings for the next 12 months). Bank of America had the largest total share purchase approval at $30.9 billion, or roughly 11.5% of the bank’s market cap, while also raising the quarterly dividend 20% to $0.18 per share. Wells Fargo was approved to repurchase up to $23.1 billion in stock, or roughly 11% of the bank’s market cap, while increasing the quarterly dividend 13% to $0.51 per share. Citigroup was approved to repurchase up to $17.1 billion in stock, or roughly 11% of the bank’s market cap, while increasing the quarterly dividend 13% to $0.51 per share. PNC did not quite get the amount of share repurchases approved that we were hoping for, as the bank was approved for $4.3 billion, or roughly 7% of the bank’s market cap, while raising the quarterly dividend 21% to $1.15 per share. Among the regionals, Regions had the highest relative share repurchase approval, at $1.37 billion, or roughly 9% of the bank’s market cap, while we project the bank could raise the quarterly dividend by roughly 11% to $0.155 per share, based on the payout range management has given.

Though Capital One had to take a mulligan on its original capital return plan, the company announced plans to repurchase up to $2.2 billion in shares over the next 12 months while maintaining its $0.40 per share quarterly dividend. Combined, this means Capital One will return approximately $3 billion to shareholders, translating into a total payout ratio of about 60% of our projected 2019 earnings. This is a substantial improvement to last year’s plan when Capital One could only repurchase $1.2 billion in shares. Given Capital One’s comparatively weak though still acceptable performance on last week’s stress test and the pending purchase of Walmart’s card portfolio, this is more than we were expecting, and investors should treat this as a mild positive.

Goldman Sachs and Morgan Stanley both received nonobjections to their capital return plans. This compares to the previous year, when both received conditional nonobjections and had to cap their capital returns at a benchmark based on their capital returns in the previous years. Overall, both companies did fairly well in the severely adverse scenario, with Goldman Sachs' minimum common equity Tier 1 ratio being 6.7% and Morgan Stanley's being 7.7% compared with the 4.5% that regulators generally hope to see.

Goldman Sachs' capital plan is for $8.8 billion: $7 billion of repurchases and $1.8 billion of common stock dividends. On a per share basis, Goldman Sachs' quarterly common stock dividend is slated to increase nearly 50% to $1.25 from $0.85 in the third quarter of 2019, pending approval from the company's board of directors. The $8.8 billion of capital returns is equivalent to about 90% of the company's net income to common shareholders in 2018, and the new dividend equates to about a 20% payout ratio. Given where the stock is currently trading, repurchases at this level should be modestly accretive.

Morgan Stanley's capital plan calls for common stock repurchases of up to $6 billion and an increase in the quarterly dividend per share to $0.35 from $0.30 in the third quarter of 2019. The total capital plan is approximately equal to the company's $8.2 billion of net income to common shareholders reported in 2018. Shares of Morgan Stanley are currently trading at a slight discount to our fair value estimate, so repurchases near current prices should be modestly accretive.

The custody banks were well above the 4.5% common equity Tier 1 threshold in their stressed scenarios, with State Street and BNY Mellon each at 8.2% and Northern Trust at 9%. State Street plans to increase its quarterly dividend from $0.47 to $0.52 (about a 34% payout ratio based on our estimates) and the board authorized a $2.0 billion share repurchase program from third-quarter 2019 to second-quarter 2020. BNY Mellon plans to up its dividend from $0.28 to $0.31, which based on our estimates would translate to a dividend payout ratio of around 31%. The board also approved a $3.94 billion plan for share repurchases from third-quarter 2019 to second-quarter 2020. Northern Trust plans to increase its dividend from $0.60 to $0.70 (about a 41% payout ratio for Northern Trust) and has provided authorization to repurchase $1.4 billion of its shares.