The Coming Windfall for Bank Stock Investors

If analysts and commentators are right, then shareholders of the nation's biggest banks could soon see a dramatic increase in the amount of capital these banks return by way of share buybacks. This includes JPMorgan Chase (JPM 0.49%), Bank of America (BAC -0.13%), Wells Fargo (WFC -0.56%), and Citigroup (C -0.32%).

The nation's four biggest banks are expected to spend a cumulative $44 billion on buybacks this year, assuming they're cleared to do so by the Federal Reserve. Investors will learn whether this is the case on Wednesday, when the central bank is set to release results from this year's Comprehensive Capital Analysis and Review, or CCAR. That would equate to a $15 billion, or 52%, boost over 2016.

Data source: KBW.

The CCAR is the second stage in the stress tests administered each year by the Fed. The purpose of the stress tests is to gauge whether large banks -- those with more than $50 billion in assets on their balance sheet -- have enough high-quality capital to survive an acute economic downturn akin to the financial crisis.

The first round, referred to as the Dodd-Frank Act stress tests, or DFAST, is purely quantitative in nature. Banks either have enough capital to pass it or they don't. The key threshold is a common equity tier 1 capital ratio, or CET1 ratio, of 4.5%. So long as a bank's regulatory capital stays above that, it's good to go.

This wasn't a problem for any of these four banks -- or, quite frankly, for any of the 34 banks that took this year's test. Wells Fargo's CET1 ratio bottomed out at 8.6% at the nadir of the test's nine-quarter horizon. Meanwhile, Citigroup, JPMorgan Chase, and Bank of America's low points weighed in at 9.7%, 9.1%, and 8.9%, respectively.

Bank of America's headquarters looms over downtown Charlotte, North Carolina. Image source: Getty Images.

These banks thus head into the 2017 CCAR with an overabundance of capital in excess of the regulatory minimum. It's for this reason that analysts expect JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup to all request, and get approval for, meaningful increases in the amount of capital they return to shareholders.

Banks can do this in one of two ways. They can increase their quarterly dividend payouts, which all four of these banks are expected to do this year. A bank can also return capital by buying back stock, as doing so consolidates ownership around fewer shareholders and therefore makes their remaining stakes more valuable.

It's always possible, of course, that any or all of these banks could run into problems on this year's CCAR that would prevent them from accelerating their capital return programs. But assuming they don't, and that seems to be the likeliest outcome, then shareholders in these banks could be in for a capital windfall.