Bank shareholders have reason to celebrate. The recently published U.S. regulatory stress test results will allow many of the largest banks to resume payouts to shareholders in line with pre-crisis averages. Bondholders have good reason to be happy too, as fundamentals continue to improve and regulators will still require the largest banks to retain over a third of their net income.
U.S. banks have been on a secular journey toward higher capital and better liquidity since the financial crisis. Capital levels are up 60% from pre-crisis averages to the highest levels in most people’s lifetimes and banks have significantly reduced the potential for a “run on the bank” due to low liquidity. The stress test results show that banks now have enough cushion to withstand losses greater than those suffered during the financial crisis.
Importantly for bondholders, the Fed will only allow banks to return about 60%–65% of this year’s earnings to equity holders with payouts expected to reach a post-crisis high of $80 billion in dividends and share buybacks. Based on aggregate expected after-tax profitability of roughly $130 billion for the largest banks, this amounts to capital retention of over $50 billion in the coming year – money that will bolster banks’ capital positions and which banks can use to fund new loan growth.
Payout levels will vary widely among banks, with higher payouts approved for regional banks than for the largest global systemically important financial institutions (G-SIFIs) such as Bank of America and Citigroup. Regulations such as the G-SIFI capital surcharge and the Supplemental Leverage Ratio (SLR) remain a throttle on the largest banks’ payout capacity.
Regulation has influenced issuance of bank capital securities globally as well, which creates opportunities for investors to capitalize on new issue premiums and attractive yields. Shortly after the stress test results were released, we saw issuance of about $5 billion of new debt capital instruments from Bank of America, Citigroup and Morgan Stanley alone. This supports PIMCO’s view that fundamental and regulatory changes in global banking are leading to many investment opportunities across the capital structure for investors with expertise in regional, company and security differences.