Megabanks and some consumer finance companies appeared to benefit the most from the Federal Reserve's surprise decision to relax restrictions on capital distributions.
Analysts wrote that the nation's largest banks and a couple of consumer-focused lenders would be able to increase share repurchases the most relative to baseline expectations. Investors took note, pushing the names higher by roughly 4% on Dec. 21 when the broader market was down slightly.
JPMorgan Chase & Co. gained 3.8% while Bank of America Corp. and Citigroup Inc. were right behind, each with 3.7% gains. Fellow megabank Wells Fargo & Co., still stuck in regulatory purgatory, lagged with a 1.9% gain. Still, Wells Fargo beat the S&P 500, which dropped 0.4% on the day. And while the SNL U.S. Bank and Thrift index was up by 2.0%, the gain appeared to be driven by larger banks as the SNL index for banks with $5 billion to $10 billion in assets dropped 1.3%.
"While certain individual bank management teams have been more optimistic about repurchase resumptions as soon as 1Q21, we do not believe that most investors felt this was likely until later in 2021," wrote analysts at Piper Sandler.
The Fed banned share repurchases and capped dividends in the initial round of the Fed's stress testing and capital planning exercise, released in June. Due to the extraordinary economic environment amid the COVID-19 pandemic, regulators required a second round of stress tests. Those results, released Dec. 18, showed banks with capital buffers sufficient to withstand the hypothetical stressed scenarios.
While analysts generally expected banks to pass the stress test, the Fed's decision to allow share buybacks came as a surprise. The Fed will allow share repurchases and dividends in the first quarter of 2021, but the amount will be limited to the bank's net income over the past year.
Fitch Ratings issued a note saying that its analysts were still "cautious" about banks distributing capital due to the continued economic uncertainty driven by the continuing pandemic. "However, easing dividend and buyback restrictions reflect the strength of banks' capital at the onset of the pandemic," its ratings analysts wrote.
Some equity analysts noted that Capital One Financial Corp. might be the greatest beneficiary from the Fed's shareholder distribution relaxation. Capital One cut its dividend after the first round of stress tests, lowering it to 10 cents per share from 40 cents per share. Piper Sandler's analysts wrote that the company could now increase its dividend back to 40 cents per share as well as buy back up to 2.5% of outstanding shares over the next two quarters.
Analysts at Keefe Bruyette & Woods tagged Capital One as the bank that could see the largest EPS boost from share repurchases, assuming banks maxed out their allowed buybacks. Doing so would increase Capital One's 2022 EPS by 9.2% from the analysts' previous estimate. Analysts noted that this was due, in part, to their current model having zero share repurchases in 2021. The same held true for another consumer finance company, Ally Financial Inc., which saw an 8.6% jump in its EPS estimate for 2022 due to share repurchases.
Both consumer finance companies posted strong gains Dec. 21 following the release of the stress test results. Capital One gained 4.1% and Ally shares increased by 3.5%. Among all banks in the stress test exercise, Goldman Sachs Group Inc. posted the largest jump at 6.1%, followed by Morgan Stanley at 5.7%. KBW analysts highlighted the pair of investment banks in their note as seeing a significant upside to 2022 estimates with larger repurchases, forecasting a 5.6% jump in Goldman Sachs' earnings and a 4.9% increase in Morgan Stanley's if the banks repurchased shares at their maximum levels.
Investor optimism around megabanks persisted despite the banks showing the largest net losses under the stress test. Bank of America posted the largest net loss at $30.5 billion across the hypothetical nine-quarter stressed environment, followed by Wells Fargo, Goldman Sachs, JPMorgan, and Morgan Stanley. For loan losses as a portion of average loan balances, Discover Financial Services posted the largest loss at 21.3% across the nine-quarter stress test, followed by Capital One with a total loan loss rate of 17.0%.
Click here to access a template with the Federal Reserve-run December 2020 stress-test results pertaining to loan losses and profitability projections for the 33 participating bank holding companies, under the severely adverse scenario.