Quick Thoughts – BAC Capital Tsunami: Expect Stock Buyback of over $10bn in 2015
Last night, the Fed announced its review of bank capital plans for 2014 (March through March), including BAC.
BAC was approved to buyback $4bn of stock and raised the dividend to 5 cents/quarter from a token penny. BAC also announced it had settled with FHFA, as conservator of Fannie and Freddie, over mortgage litigation and agreed to make a cash payment of $6.3bn and repurchase some RMBS at fair value of $3bn.
The media is reporting this as a $9bn settlement which is the face value but, after taking account of the RMBS exchange, the cost is $6.3bn. Because of reserves, the impact on 2014Q1 earnings is $3.7bn pre-tax and ~$2.5bn after-tax.
Adding the buyback, dividend, and after-tax settlement comes to $8.8bn which is in line with our model for excess capital generation in 2014. The model simply assumes a stable tangible equity/assets ratio of 7.7% and the match with the outcome result bears out CEO Brian Moynihan’s comment on CNBC in early November to the effect that, if the overall capital ratio was sound, the stress tests would work out. In practice, BAC had hoped to run at a higher leverage, with a tangible equity/asset ratio of “just over 7%”, and asked for the ability to return more capital, but had to revise down its plan for Fed approval.
Our model suggests that, at the current tangible equity/assets ratio, excess capital generation in 2015 increases to over $15bn so that the dividend can increase to 30 cents and buyback can more-than-double to ~$10bn even if BAC earnings are reduced by ~$5bn for further litigation (or $7bn before tax and after reserves). Obviously, capital generation is higher still if BAC is able to reduce the tangible equity/assets ratio which likely depends on resolving litigation risk. The FT is reporting that BAC may settle with the DoJ and state authorities for $7.5bn and, of course, Preet Bharara and Countrywide whistleblower, Edward O’Donnell, are looking for ~$2.1bn after winning civil litigation in October that Countrywide’s “hustle” fast-track mortgage sales practices defrauded Fannie and Freddie.
We are raising our one-year target price for BAC from $22 to $24 based on 1.5x TBV and a roll-forward of the TBV/share estimate from the end-2014 of just under $15 to the end-2015 of $16.