You wouldn’t necessarily know it, but late last month (June 2016) the Federal Reserve released the results of one of the major stress tests performed on the US banking system.
Apart from a few banking sector specialists, little attention seems to have been paid to the results of the 2016 “Comprehensive Capital Analysis & Review” (or CCAR, as it’s more commonly known)*.
Admittedly the Fed published the results shortly after the UK referendum, so perhaps investors were focusing on the fallout from Brexit. But the fact that the market hasn’t reacted to the results of the 2016 CCAR perhaps shows that US banks are no longer on investors’ worries list and is an indication of how far the US banking system has progressed in terms of cleaning up balance sheets and rebuilding capital ratios.
One interesting outcome of the 2016 CCAR however is that pay-out ratios (dividends and share buyback as % of net income) are now back above pre-crisis levels, as this chart from Barclays Research shows.
Some people may look at this chart and think it’s a good thing that pay-outs have recovered, as it shows that US banks are “healthy” again. Other people may worry given the last time pay-outs were at this level, they proved to be unsustainable.
I believe the situation is more complicated and nuanced than these two opposing views. Firstly, as can be seen from the chart, the mix of distributions has shifted much more towards share buybacks. We generally prefer dividends to buybacks, but in this instance acknowledge that buybacks provide the US banks much greater flexibility in terms of their capital planning.
Secondly it’s also important to note that the Fed effectively approves these capital returns as part of the CCAR process. Regulators are not infallible, but this is a level of oversight that wasn’t in place pre-financial crisis.
When analysing US banks there are a huge number of other important factors to consider, including net interest margin, capital ratios, cost income ratios, credit losses, the macro environment (to name but a few!). We will hear more about these factors in the Q2 reporting season which began last week.
Nevertheless, it seems evident that US banks have come a long way since the financial crisis, as demonstrated by the nature of their shareholder distributions and the regulatory regime they now operate under.
*The Federal Reserve’s annual CCAR is an intensive assessment of the capital adequacy, capital planning processes and proposed capital distributions of the largest US bank holding companies (BHC). It aims to ensure that they have robust, forward-looking capital planning processes, supported by robust risk measurement practices and sufficient capital to continue operations throughout times of economic and financial stress. The CCAR applies to all BHC’s with assets greater than $50 billion and requires them to develop and submit a capital plan (proposed dividend payments and stock repurchases) to the Federal Reserve and to request prior approval before making a capital distribution.
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