As bond prices slump, U.S. banks could slow stock buybacks

Content of the article

NEW YORK – Bankers on Wall Street have long talked about how higher interest rates will generate additional income through loans and higher-yielding securities.

Now that rates are rising, bankers have to deal with the downside: as yields rise, the bonds they already own lose value and erode their capital.

For the largest US banks, this means less excess capital to fund share buybacks. Fewer buybacks mean less growth in earnings per share, which puts more pressure on stock prices.

The S&P Banks Index is down 11% year-to-date, nearly double the benchmark S&P 500’s 6% decline over the same period.

Advertisement 2

Content of the article

“You’re going to see much weaker redemptions than last year in the US banking system,” said banking analyst Charles Peabody of Portales Partners.

Bank of America Corp could post one of the biggest capital declines due to falling bond prices when banks start reporting quarterly earnings next week, analysts said, as it acted more aggressively than before. others to invest additional cash in securities last year.

“I’m pretty sure you’ll see that they slowed their buybacks significantly in the first quarter and mainly because of this issue,” Peabody said.

Bank of America declined to comment.

DOUBLE-EDGED SWORD

The lost capital should eventually be compensated by higher rates improving net interest income. But now is not a good time for buybacks, analysts said.

Advertisement 3

Content of the article

“Rising interest rates are a double-edged sword for banks,” Jefferies analyst Ken Usdin wrote in a report.

In the first quarter, 10-year US Treasury yields rose 0.83 percentage points to 2.34%. A full one-point increase would have reduced Bank of America’s Common Equity Tier 1 capital ratio, a key regulatory measure, to 10.2% from 10.6%, Usdin estimated.

That would leave the bank close to the 10% to 10.5% level that Bank of America executives said the bank would hold to keep a cushion above its 9.5% requirement from regulators.

Citigroup Inc would have seen its CET1 ratio reduced by 0.22 points while JPMorgan Chase & Co would have seen a drop of 0.15 points, Usdin.

Citigroup and JPMorgan have additional reasons to cut buybacks, Peabody noted. Citigroup will likely face losses on its Russian assets and he said these could reach nearly $5 billion in a “severe” scenario.

Advertisement 4

Content of the article

JPMorgan CEO Jamie Dimon said in a letter to shareholders on Monday that his bank’s redemptions “will be weaker over the next year” as it faces higher capital needs and needs to invest in businesses. that she recently acquired.

When the banks release their results, analysts will examine how each changed its cash and securities mix to boost interest income and managed the risk of unrealized securities losses.

Banks have taken steps to reduce the damage from unrealized losses, including hedging holdings like Bank of America does.

Banks can also make an accounting choice that tempers risk. They may classify certain bonds as “held to maturity” (HTM) and not be required to recognize changes in value if they agree to hold the securities until they are redeemed.

Advertisement 5

Content of the article

Alternatively, banks can keep the bonds as “available for sale” (AFS), which means that they must book unrealized losses against capital, but are free to sell the securities, for example to raise funds to grant more loans.

Portfolios of bank securities have fallen to 47% held to maturity, from 28% two years ago, according to Usdin.

Most banks are small enough that regulators do not require them to factor changes in AFS securities into their capital requirements.

Whether AFS or HTM, unrealized capital losses do not reduce the result.

Peabody expects investors to focus more on capital changes in the coming quarters if bond prices continue to fall. Indeed, changes in capital, also known as book value, may be a better indicator than earnings of whether companies are building shareholder value or accumulating losses to be realized later.

Usdin estimated that the book value per share of the 20 banks it covers would decline an average of 4% with a 1 percentage point increase in 10-year yields. (Reporting by David Henry in New York. Additional reporting by Sinead Carew. Editing by Matt Scuffham and David Gregorio)

Advertisement

comments

Postmedia is committed to maintaining a lively yet civil discussion forum and encourages all readers to share their views on our articles. Comments can take up to an hour to be moderated before appearing on the site. We ask that you keep your comments relevant and respectful. We have enabled email notifications. You will now receive an email if you receive a reply to your comment, if there is an update to a comment thread you follow, or if a user follows you comments. See our Community Guidelines for more information and details on how to adjust your email settings.

Comments are closed.