These 3 banks buy back shares. Should they?
In 2020, the big banks were preparing for a pandemic-related disaster. Expecting a wave of defaults, they got richer by setting aside huge amounts of loan loss reserves. After the Federal Reserve released the results of its annual stress test in June, it acted to ensure capital stability by banning big banks from repurchasing stocks and limiting their dividend payments. But in December, after an unprecedented second round of stress tests, the Fed announced it would allow banks to repurchase stocks – and a few of them announced they would.
Share buybacks are a tax-efficient way for companies to return capital to their shareholders. Repurchased shares are withdrawn, which increases each investor’s claim to earnings. Over time, buybacks increase earnings per share, which should cause the share price to rise. Unlike dividends, which are taxed immediately and eventually at your income tax rate, stock appreciation tax does not have to be paid until you choose to sell.
But there is a catch – it only benefits investors if the stock is genuinely a good buy. Let’s look at three banks that are currently working on share buyback programs – JPMorgan Chase (NYSE: JPM), Wells fargo (NYSE: WFC), and Ally Financial (NYSE: ALLY) – and see if we should join them.
JPMorgan Chase was the first bank to break out of the blocks, announcing on the same day as the Fed that it would resume share buybacks in 2021. It followed up on the announcement. Until the end of the first quarter, the company repurchased $ 4.3 billion of shares and has the capacity to repurchase an additional $ 7.4 billion in the second quarter. But do these redemptions constitute a good use of capital?
Share buybacks are only profitable for shareholders if they are carried out when the stock is undervalued. If the company repurchases overvalued stocks, it deploys capital for a low expected future return. There are probably better ways to use capital – for example, expanding or paying a dividend.
JPMorgan appears undervalued by at least two metrics: its price-to-earnings (P / E) ratio of 13 and its price-to-book (P / B) ratio of 2 are both well below industry averages. In addition, a level 1 capital ratio above 13% means that the company has sufficient capital to distribute to shareholders.
It’s hard for banks that are too big to fail to really impress the market with their quarterly profits because they are so huge. But that’s exactly what JPMorgan did in the first quarter, beating Wall Street estimates by more than 45% thanks to massive growth in investment banking fees and a release of loan loss reserves. However, be careful based on these numbers – releases of loan loss reserves do not happen often, and the increase in investment banking fees has been helped by the likely unsustainable boom in acquisition companies in special vocation (SPAC). The total net benefit of the release of reserves was $ 4.2 billion; the company still has total reserves of $ 26 billion. And the investment bank’s share subscription soared $ 1.1 billion, or 67%, last year.
Wells Fargo was also quick to announce plans to repurchase shares after the Fed’s announcement last year, but its situation is a bit more complicated.
The bank was punished for its fake accounts scandal with an asset cap of $ 1.95 trillion in 2018. This means the bank is not allowed to accumulate more assets than the cap, limiting its growth . Many expect that cap to be lifted in 2021, which should lead to more cash flow that can be distributed to shareholders.
Wells Fargo’s board of directors increased the total authorized repurchase amount to 667 million shares in December of last year. In the first quarter, Wells had repurchased just 17.2 million shares, which was just under $ 600 million.
Stocks have had a warm period since the start of the year (up around 55%) and management may wait for price to cool down to complete the full program. That said, Wells Fargo’s P / B of just under 1.2 is extremely low, and the possible lifting of the asset cap is likely to push the price even higher.
Ally embarked on a $ 1.6 billion share buyback program in early 2021 and, during the first quarter, repurchased $ 219 million of shares. Management said in the presentation of first quarter results that it was on track to complete the total of $ 1.6 billion by the end of the year.
Ally is the group’s only Internet-only bank. He has developed one of the nation’s largest auto lenders online and is leveraging that expertise in a post-COVID world to expand further into personal loans and real estate mortgages. First quarter mortgage creation increased 145% year-over-year and gross loan creation 179.
Like JPMorgan Chase and Wells Fargo, Ally seems undervalued at the moment. My foolish colleague Anthony Di Pizio sees significant benefits over the next few years. This makes its stock a great investment, and continued buybacks should help close the gap between the current stock price and the bank’s intrinsic value.
Each of the three banks we looked at is rightly undervalued or valued, and each focuses on returning capital through buyouts. As long as stocks remain undervalued, shareholders should encourage repurchase plans.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.