The chief executive officer of BB&T (NYSE: BBT ) recently announced that the bank is much more likely to boost buybacks next year as opposed to its quarterly dividend payout. "[Y]ou might think about us looking more positively toward buybacks as we head into 2014 relative to, say, the last two or three years," CEO Kelly King noted.
The issue of dividends versus buybacks is a hotly contested one. Company executives pitch it as a way to "return capital to shareholders." I, and others, have a different view -- and particularly when it comes to banks buying back their own stock.
A colossal waste of capital
It's no exaggeration to say that the last decade has been a veritable house of horrors when it comes to repurchase programs by the nation's leading lenders.
In the five years between (and including) 2003 and 2007, Bank of America (NYSE: BAC ) spent $40 billion to repurchase 768 million shares of its common stock. One year later, its capital base was so depleted it needed $45 billion from the federal government just to survive.
And Citigroup (NYSE: C ) put itself in a nearly identical situation. In the decade before the crisis, it bought back $41 billion of its own stock. By 2009, it too required a $45 billion taxpayer-funded bailout to stay afloat.
How can a similar fate be avoided?
This is an important question, and it's one that few analysts and commentators give enough attention to, choosing instead to simply co-op the management's talking points about the benefits of returning capital to shareholders.
The answer, it turns out, is straightforward. As I discussed here, in order for a buyback to be accretive to book value on an ongoing basis, a bank should generally avoid repurchasing stock when it's priced at a multiple to book value that exceeds its return on equity.
U.S. Bancorp (NYSE: USB ) serves as a perfect example. The Minnesota-based lender is one of the best in the country and accordingly trades for a dear 1.96 times book value. Thus, in order for a buyback program to be accretive to its book value per share, its return on equity must be 96% or higher -- an impossible task even for an organization of U.S. Bancorp's caliber.
Getting back to BB&T
With these examples in mind, one would be excused for wondering why such an ostensibly shareholder-friendly bank such as BB&T would be even remotely interested in initiating a new buyback program given that its shares trade for 1.28 times book value versus a 9.2% return on equity over the last 12 months.
The answer is twofold. In the first case, given King's assessment of an overall "sluggish" economic environment, there are few places inside the operation to put the cash to work that would produce satisfactory returns on investment. And on top of this, there's nothing "imminent out there" on the mergers and acquisition front.
In the second case, since the financial crisis, banks have been reluctant to increase their dividend payouts if their payout ratio already exceeds 30%. According to the Federal Reserve, "Plans with dividend payouts greater than 30 percent of net income ... [receive] particularly close scrutiny."
At present, BB&T's payout ratio comes in at 46% -- well above the 30% threshold.
In sum, regardless of the reason, BB&T has effectively concluded that it's better to impair its own book value rather than face the heightened scrutiny from the Fed or to simply allow its accumulated earnings to gather dust in its capital account.
Is this the right decision? That remains to be seen, but I'm skeptical.
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