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 The big banks are already holding more capital than regulators have
said they will need by the end of 2018. As banks begin reporting
fourth-quarter earnings this week, starting with JPMorgan Chase & Co
and Wells Fargo & Co on Wednesday, investors could learn that banks
became even more over-capitalized in the last three months.
But hopes that some of that capital will find its way to
shareholders seem likely to be unfulfilled. Expected loan losses are
rising, especially in the energy sector, and trading markets are
becoming more volatile, which makes bank assets riskier. Regulators
are less willing to approve big increases in dividends or share
buybacks when assets are riskier, analysts said.
Banks' likely difficulty in raising dividends or buying back more
shares would be only the latest headache for investors. Since the
2008 financial crisis, partly caused by banks' bad lending and bond
underwriting practices, banks have entered huge legal settlements
and have struggled to boost their revenue. Historically low interest
rates have also depressed earnings.
Paying higher dividends was supposed to be a spur to boost stock
valuations in the sector.
Banks pay out a much lower percentage of their earnings than they
used to. Between 1999 and 2006, big banks on average paid about
three-quarters of their income out as dividends or share buy backs,
according to analysts at Credit Suisse, but the ratio in the last
few years has been under 50 percent.
The decline in payouts comes in large part because regulators
started overseeing dividend payments and share buybacks in 2009. The
Federal Reserve was looking to prevent a repeat of 2007 and 2008,
where banks paid out more than they earned. Banks have trouble
cutting dividends in tough times because they fear the move will
signal weakness to customers and investors, further weakening their
business.
Investors are unsure when that will change.
"Banks are set up to be able to pay out more and they will do that —
we just don't know when," said Tony Scherrer, director of research
at Smead Capital Management, which owns shares in Bank of America
Corp, Wells Fargo & Co and JPMorgan Chase & Co.
The biggest banks are seeking approval for their 2015 dividend plans
with the Federal Reserve now, and will learn the results in March.
Of the largest U.S. banks, Citigroup Inc's shareholders may be the
most disappointed with low dividend increases in 2015, analysts
said. Citigroup has paid the lowest percentage of its profit as
dividends to investors of any of the big banks since the crisis —
just 1 percent in 2013. Citigroup declined to comment.
RISKIER BUSINESS
Before the last few weeks, investors and bank executives had been
hopeful about higher payouts because of the increase in capital.
Loan defaults have been falling thanks to an improving U.S. economy,
particularly for commercial loans, giving regulators more comfort
about banks paying out earnings to investors. For instance, in the
third quarter Wells Fargo not only did not lose a single dollar on
commercial loans that went bad; in fact, it recovered $24 million
from borrowers who had defaulted.
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But energy companies have accounted for a growing share of
commercial loans at many banks, and with oil prices having fallen 50
percent in recent months, investors are concerned about rising loan
defaults in the coming year.
"Commercial losses are unsustainably low," said Ryan Nash, a bank
analyst at Goldman Sachs Group Inc last week. "Somebody is going to
have an impact from the fact that oil prices are $47 a barrel just
now. It’s hard to say who it is."
Trading assets have become riskier as well, as prices across markets
have oscillated wildly. From the beginning of 2013 through most of
2014, the average daily trading range for the Standard & Poor's 500
index was 15 points; in the last three weeks it has jumped up to a
daily average of 25 points.
Treasury yields have fallen unexpectedly as well, which in addition
to making bond markets more volatile, also cuts the income banks can
earn on the portfolios of securities they hold, and drives down some
lending rates.
Any increases in credit losses and market riskiness will have a big
effect on how regulators look at bank's safety levels. The Federal
Reserve adjusts banks' capital requirements based on the riskiness
of their assets, using an adjustment known as "risk-weighted
assets," with riskier assets requiring more capital.
Charlie Peabody, a veteran bank analyst at Portales Partners,
calculates that a 30 percent increase in Citigroup’s risk-weighted
assets - an event he thinks is likely over the next two years -
would reduce the bank's regulatory capital ratios from 10.47 percent
to 8.05 percent, below its internal minimum of 9.5 percent and too
low to expand dividends or repurchases.
A decline in expected payouts for Citigroup could be a big problem
for its shares. A poll of investors at a November conference hosted
by Bank of America Corp found that two-thirds believed the biggest
catalyst for Citigroup’s stock price going forward was getting
permission from regulators to return more capital to shareholders.
(Reporting by Peter Rudegeair, editing by Dan Wilchins and John
Pickering)
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