U.S. banks are set to raise dividends and buy back stocks after the U.S. Fed gave the thumbs up for both. Will this be enough to give another boost to bank stocks? And could Canadian banks follow suit? Kim Parlee talks with Monica Yeung, Global Financials Analyst, TD Asset Management.
- The fact that all 23 of the biggest banks in the US passed a stress test with flying colors and the regulators have authorized stock buybacks, is that a strong signal that all systems are go for the US banks?
- Well, first of all, thanks for having me, Kim. Great to be here as always. Big win for the US banks. As you noted, all of the largest US financial institutions passed this year's Fed stress test with flying colors. Really important milestone because, as you noted, it unlocks billions of buybacks and dividends. Previously, the Fed had put in place restrictions on capital returns during the pandemic. Due to the stress test results, those restrictions have now been lifted. And as of July 1, the large US banks are free to buy back stock, pay out dividends in much larger quantities than before.
I'd say big picture, very positive for the sector. The regulators have basically written a clean bill of health for the US banks. I think it really reiterates the point that these banks are safe. They're sound. They're strong, well-capitalized, resilient.
More broadly as well, I think it's a signal that the regulators view the COVID pandemic, the worst of it as in the rearview mirror. And also, we're firmly in recovery mode now in the US. All systems are go in terms of the economic rebound.
- That's some nice news to hear. And you went through a list of what you think is actually showing. When you look at the big six banks in the US, any key standouts in terms of the messaging or what's been coming out?
- Well, I mean, let's put some numbers into context. You look at the big six banks, all of them, like I said, passed the Fed stress test. In fact, last week, five of those six actually raised their dividends meaningfully, on average up about 50%.
Two really big standouts, the first one is Morgan Stanley. They had very good performance on the stress test. Saw their capital requirements actually decline. And so they felt comfortable increasing their dividend by 100%. They've also had very strong performance in their underlying business in capital markets and wealth management. And so I think all of that really points to their ability to raise their dividend. They also actually upsized their buyback program.
On the other side of the point, you have Citibank. Citibank actually saw their capital requirements increase due to the Fed stress test, so they weren't comfortable increasing their dividend. They kept their dividend flat. So definitely some winners, some losers in this round of the cycle.
I guess that's-- the big question is just how much of this is priced in. I mean, you talked about a couple of banks, big dividend increases, some starting buybacks. But you know, is there more to come? And how much more material would it be?
- Well, I guess the one thing I haven't mentioned is buybacks. Yeah, you mentioned it just now. Quite material for the sector-- in fact, if you looked at those big six banks that I mentioned earlier, if you looked at their excess capital today, they have the capacity to buy back up to 10% of their shares outstanding. Not to say that they will do the full thing. Even if they bought back, 6%, 7%, 8%, you layer on top of that some loan growth in 2022, possibly some rate hikes in 2023 or even next year. That's pretty material in terms of earnings growth. It's really going to supercharge the US banks' EPS, and I think will be supportive for share prices looking ahead.
- Which banks are you watching to really be able to leverage the US recovery beyond all the dividends and share buybacks?
- One name to watch, one name that I'm certainly watching is Bank of America. I feel like they're a very good barometer for the US recovery for a few reasons. Firstly, they do have a sizable consumer franchise, and so they're a big lender in credit cards and auto loans. And you would think about the US recovery, consumers are going to be out there spending more on travel, on entertainment, on durable goods. And that's really going to benefit their top line.
Bank of America also is the most rate sensitive bank out of the large cap banks. And in fact, a 100 basis point parallel shift in the yield curve would result in 30% uplift to their earnings in one fell swoop. So definitely a name to watch and one that I am watching over the next 12 months.
- And we'll have to see, of course, what the Fed does to make that happen. But yeah, that's a big multiplier effect. What are you seeing-- what would you think about the Canadian banks? I mean, the Canadian regulator is not lifting restrictions at the same timeline as US regulators. So what are you watching there?
- I mean, as you noted, right now, the Canadian banks are not able to raise their dividend and not able to buy back stock. That's a restriction that's been in place since 2020 in the midst of the pandemic, and OSFI has not yet relaxed it. I think it's very likely, however, we'll see that restriction come off or loosened sometime in the next few months. I'm looking at the pace of vaccinations in Canada, the pace of reopenings, also, just expectations for a strong economic recovery in the back half of the year. And I think we would be hard-pressed to see a situation where some of those restrictions don't relax.
In all fairness, OSFI's been pretty quiet in terms of their intentions. A few reasons for that-- we do have a new superintendent who took office just last week, Peter Routledge. And so I think he'll want to settle in for a few weeks, a few months before making that decision. I think more generally, the Canadian regulator is a lot more conservative in its approach, much more conservative in making decisions like this. So I think they want to see the Canadian banks firmly in recovery before relaxing the restrictions on dividend buybacks.
- Which I would think be consistent with history, just given the conservative nature of the financial sector. I've only got about a minute here, Monica. But I mean, what do you expect to see from Canadian banks when they do get the green light to move ahead with dividends or share buybacks or be able to release some of that capital?
- It's very material, something that could be very big for the sector. In fact, when you look at excess capital positions today versus regulatory minimums, in aggregate, the big six hold about $50 billion of excess capital, about 8% of their market cap.
So I think they'd look to deploy it in three ways. Firstly, they probably hike their dividend, look to deploy some of that into buybacks, and also invest in their business, both organically, inorganically. We know a number of banks like TD, BMO looking to do acquisitions in the US.
- Banks have had a pretty big run-- I'm going to squeeze in this last question-- year-to-date. Do you see them more upside from a valuation perspective?
- In terms of valuation, Canadian US banks trading 11 to 12 times, that's certainly not demanding by any stretch, certainly when you compare it to the rest of the market. I think they're paying an attractive dividend. More importantly, they have a very strong earnings growth story for many of the reasons that we talked about earlier today. And so we remain very bullish, very constructive on the bank sector, both in Canada and the US.
- Monica, always great to have you with us. Thanks so much.
- Thanks for having me.