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 Much of the money for buybacks and higher dividends is coming from
the banks issuing securities known as preferred shares. These shares
are a type of equity that pays regular, relatively high dividends.
To investors they look a lot like bonds that pay interest. But for
regulators, preferred shares serve as a cushion against any future
losses, in part because they never have to be repaid.
Critics of the strategy question how sustainable it is, as banks
essentially take money from one set of investors and give it to
another, and at an added cost.
Issuing preferred shares to pay for common share dividends and
buybacks is a symptom of a "zombie banking system," said veteran
banking analyst David Hendler of independent research firm Viola
Risk Advisors.
"Banks should be building capital from normal lending and trading
profits, but their operating income is terrible," he added.
Income has been falling or stagnant at the biggest Wall Street
banks, thanks in part to big legal settlements stemming from the
financial crisis. For the U.S. banking system as a whole, operating
income in 2014 was $151.15 billion, down 0.4 percent from the year
before, according to the Federal Deposit Insurance Corp.
Spokesmen for Citigroup, JPMorgan and the Federal Reserve declined
to comment.
To be sure, the steps banks are taking are within regulators' rules.
The Federal Reserve allows banks to use preferred shares for at
least part of their capital.
Citigroup, for example, issued $3.7 billion of preferred shares in
2014 and has publicly disclosed plans to issue $4 billion of
preferred shares this year and another $4 billion to $6 billion
before 2019.
Veteran bank analyst Mike Mayo, who is at brokerage CLSA, estimates
that the bank will ask to return roughly $7 billion of extra capital
annually to shareholders in the coming year. “The preferred gives
them an extra cushion” over minimum capital requirements to make the
payouts, Mayo said.
Selling preferred shares to boost payouts to common shareholders
can't go on forever without banks improving their results enough to
boost their capital levels significantly.
Mayo expects that next year Citigroup will come up with additional
excess capital from a planned sale of assets, including its OneMain
personal lending unit.
JPMorgan issued nearly $9 billion of preferred shares this past year
and other banks have said they expect to issue more. JPMorgan said
in February that the sales will go toward satisfying pending
requirements that big banks have enough capital to absorb losses in
a financial crisis.
JPMorgan will likely win approval to increase its dividend by 10
percent and buy back stock at an annual rate of $7.3 billion a year,
up 25 percent from last year, according to analyst John McDonald of
Bernstein Research.
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INVESTORS HOLD THEIR NOSES
Bank executives started publicly toying with the idea of issuing
preferred shares a few years ago as they looked for ways to meet
higher capital requirements that are being phased in through 2019.
In 2014, JPMorgan sold $8.9 billion of preferred shares over six
different offerings. The money wasn't cheap. Dividends on five of
the six issues topped 6 percent as of the end of December, according
to the company's annual filing with the U.S. Securities and Exchange
Commission.
Dividend yields on bank preferreds have been about four percentage
points higher than yields on 10-year bank debt, according to
Barclays’ fixed-income research. Bank debt would, though, be paid
out before preferred shares in the event of a bank liquidation,
making it a safer bet for investors.
Declared dividends for all of JPMorgan's preferreds amounted to $1.1
billion in 2014, compared with $6.1 billion in common dividends. For
common shareholders, the preferred dividends were subtracted from
the company's reported net income, leaving $20.6 billion for common
equity and reducing earnings per share by about 30 cents, or 5
percent. That in itself can hold back a bank's share price.
Buyers of preferred shares are attracted by the high dividends. They
take a sizeable risk because often the bank will never redeem the
shares, and they can only be sold to other investors. Dividends may
also be suspended on the securities.
"Out of necessity, they hold their noses and buy it," Viola's
Hendler said. The shares wouldn't have the same appeal if yields on
bank debt weren't so low, he added.
(Reporting by David Henry in New York; Editing by Dan Wilchins and
Martin Howell)
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