How Much Could Bank of America Spend on Buybacks if Regulators Weren't an Issue?

By John Maxfield Markets Fool.com

If you're an investor in bank stocks, there's a simple reason you want to consider owning shares of Bank of America (NYSE: BAC): Starting as soon as next year, the nation's second-biggest bank by assets could be in a position to spend tens of billions of dollars buying back stock.

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The only reason Bank of America hasn't done so until now -- though it has been spending a few billion dollars a year on buybacks -- is because the Federal Reserve controls how much money banks return to shareholders through dividends and buybacks.

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Many banks, like Bank of America, have thus been stuck with more capital than they'd otherwise choose to operate with. This is one of the reasons profitability is down so far compared to before the financial crisis -- higher compliance costs and ultralow interest rates are the other principal explanations.

But this could soon change. The now-former Fed governor in charge of regulating banks said earlier this year that it may be time to eliminate the qualitative portion of the annual stress tests, which is why most banks have been denied dividend or buyback requests in the past.

President Trump's vow to deregulate the financial services industry seems to only assure that this will happen, as would the legislative proposal to replace the Dodd-Frank Act created by Rep. Jeb Hensarling of Texas.

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Assuming Bank of America eventually regains control of its capital plans, in turn, just how much capital could it unleash on shareholders? This seems like an easy question, but there are three ways to answer it.

The first is to look at how much capital Bank of America is holding right now relative to how much regulators require it to hold.

Measure

Common Equity Tier 1 Ratio*

Common Equity Tier 1 Capital*

Actual

11%

$167,351

Regulatory minimum

7.25%

$109,961

Excess

4.75%

$57,390

*Advanced approaches. Data source: Bank of America.

Based on this, Bank of America could return $57 billion in capital. But if that sounds like too much, you're probably right.

That's because the regulatory minimum for Bank of America will eventually increase to 9.5%, as the most recent changes to the capital rules fully phase in over the next few years. From Bank of America's perspective, this is a more appropriate target.

Measure

Common Equity Tier 1 Ratio*

Common Equity Tier 1 Capital*

Actual

11%

$167,351

Regulatory minimum, fully phased in

9.5%

$144,087

Excess

1.5%

$23,264

*Advanced approaches. Data source: Bank of America.

Under this scenario, Bank of America could return $23 billion of the capital on its balance sheet and still pass regulatory muster. This seems closer to what the North Carolina-based bank would actually strive for.

But there's one more constraint on Bank of America's ability to buy back stock -- namely, doing so can't cause it to fail the quantitative portion of the stress test. To pass that, the $2.2 trillion bank's common equity tier 1 ratio can't drop below 4.5%.

Measure

Common Equity Tier 1 Ratio*

Common Equity Tier 1 Capital*

Actual

11%

$167,351

Regulatory minimum to pass stress test

4.5%

$68,252

Excess

6.5%

$99,099

*Advanced approaches. Data source: Bank of America.

As you can see, this shouldn't hinder Bank of America. Even if you subtract the decline in its capital under the severely adverse economic scenario on last year's test, in which its common equity tier 1 capital was projected to drop by $63 billion, Bank of America would still have a $36 billion cushion.

In short, based on how much capital Bank of America has on its balance sheet right now compared to how much it needs to satisfy regulators and pass the annual stress tests, it could spend as much as $23 billion on buybacks in one fell swoop once it regains the discretion to do so.

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John Maxfield owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.