Share repurchases have always been an important part of the investment thesis when it comes to the megabank stocks.
But with higher capital requirements looming, many of these large banks have had to slow their buyback activity. Regulators are widely expected to release the new requirements soon and provide banks with time to phase in the changes. Speculation and media reports suggest that capital requirements for the megabanks could increase by 20%.
However, even if the big jump in regulatory capital requirements materializes, Wells Fargo (WFC -0.03%) remains in a strong position from a capital perspective to continue to buy back its own stock and return capital to shareholders. Here's why.
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Good timing
Each year, regulators assign the largest and most complex banks regulatory capital requirements. The purpose of regulatory capital is so banks can absorb unexpected losses and continue to lend in a severe economic environment.
A big capital ratio for investors to watch is the Common Equity Tier 1 (CET1) capital ratio, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets such as loans. Excess capital over bank CET1 requirements can be used to return capital to shareholders through dividends and repurchases.
While Wells Fargo seemed to move slowly in restarting share repurchases last year, the bank has been much more active this year, repurchasing $8 billion of stock through the first six months of 2023, which represents close to 5% of its roughly $170 billion market cap.
Following the Federal Reserve's annual stress testing exercise, which helps determine bank CET1 requirements each year, Wells Fargo looks like it will have a roughly 9% CET1 requirement starting later this year, which would be down from its current 9.2% requirement. The Fed will release final CET1 requirements later this year.
Now, let's just speculate and say the speculation is true and CET1 requirements for the megabanks rise 20%. That would push Wells Fargo's CET1 requirement from roughly 9% to roughly 10.8%, which isn't that much more than its actual CET1 of 10.7% as of the end of the second quarter.
"In most of the scenarios that we see, there is room for us to continue the buyback program in a prudent way and still build required capital to whatever levels we'd have to," Wells Fargo Chief Financial Officer Mike Santomassimo said on the bank's recent earnings call.
Time is on the bank's side
Remember, while regulators will announce the new requirements soon, banks will likely have a few years to phase them in, allowing them to build capital.
If CET1 requirements do rise 20%, Wells Fargo will already be almost compliant at current levels and the bank replenishes capital each quarter with earnings. The bank has earned close to $5 billion in profits in each of the last two quarters and consensus estimates from analysts have earnings rising in 2024, as the bank executes on efficiency initiatives and drives revenue from more capital-efficient sources. This doesn't include how much earnings could eventually rise if Wells Fargo ever gets its asset cap removed, which was imposed as a penalty in a fake consumer account scandal and has prevented the bank from expanding its balance sheet since early 2018.
Given that Wells Fargo is likely already near the new anticipated capital requirements, the time the bank will have to build capital, and earnings increases, I think the bank remains well positioned to continue to repurchase stock and return capital to shareholders.
