Banks Can Buy Back Stocks Again. Wall Street Is Cheering.

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Bank stocks have reason to pop the champagne before New Year’s Eve.

Shares of the sector soared on an otherwise down day for Wall Street as investors cheered the Federal Reserve’s move to allow the nation’s largest banks to resume share repurchases, subject to limitations. The

SPDR S&P Bank ETF

(ticker: KBE) was up 0.7% Monday, while shares of

JPMorgan Chase

(JPM) and

Bank of America

(BAC) gained 3.8% and 3.7%, respectively.

Soon after the Fed’s announcement Friday, JPMorgan announced plans to repurchase $30 billion worth of shares in 2021. Morgan Stanley also announced plans to buy up to $10 billion worth of shares.

Few on Wall Street expected the central bank to allow buybacks so soon. With rising coronavirus cases across the country and the specter of continued shutdowns, there remains much uncertainty about the path of the economic recovery. But after facing their second stress test of the year, banks were able to prove that they are equipped to handle an economic downturn even worse than what many economists had forecast. In drawing up the stress test scenarios earlier this year, the Fed noted they were “significantly more severe than most current baseline projections for the path of the U.S. economy.”

For banks, the Fed’s decision provided some much needed good news for the sector. While stocks from other industries have recovered from their March lows, banks lagged behind as investors worried about the impact of low interest rates and expected loan losses.

Analysts expect that buybacks will be a boon to shares when they officially resume in the first quarter of next year. Share repurchase could be as high as 10% of bank market capitalizations next year, according to Gerard Cassidy, managing director at RBC Capital Markets.

Banks are somewhat restricted in their capital return to shareholders. The combination of buybacks and dividends is capped at average earnings from the previous four quarters. Because earnings took a hit at the beginning of 2020 as banks built up their reserves for loan losses, capital return will be more muted in the first half of the year.

“As the year progresses, however, we expect buyback amounts to increase as the depressed 1Q20 and 2Q20 results are excluded from the average of the prior four quarters’ net income beginning in 2Q21,” Cassidy wrote.

With banks set to benefit from the resumption of buybacks, analysts are trying to guess who will be the winners and losers.

“We see substantial capacity to repurchase shares, with

Bank of New York Mellon

(BK),

Morgan Stanley (MS)

and

State Street

(STT) having the greatest capacity (as a % of market cap) in 1Q21, and

PNC Financial Services

(PNC),

Wells Fargo

(WFC) and

American Express

(AXP) the least,” Richard Ramsden, analyst at Goldman Sachs, wrote Monday.

Analysts at Keefe Bruyette & Woods differed slightly in their assessment of how buybacks will affect bank stocks. They expect that Wells Fargo, State Street, and

Citigroup

(C), will have the most shares to repurchase over a two-year period based on market capitalization. Based on average daily trading volumes, they expect that State Street, Bank of New York Mellon, Morgan Stanley, and

Northern Trust

would have the most shares to repurchase.

Write to Carleton English at [email protected]