Wednesday, March 20, 2013

Experts weigh in on Bank of America's buyback plan

Bank of America reached a post-recession milestone last week, with the Federal Reserve blessing its 2013 capital plan.

Rather than increase its quarterly dividend from a mere 1 cent, where it’s been since 2009, the Charlotte-based bank has opted to buy back up to $5 billion in common stock and redeem approximately $5.5 billion in preferred stock.

Before the Fed OK’d Bank of America’s capital plan, some analysts suspected that the bank would be seeking the agency’s approval for a modest  say, 2- to 3-cent  increase to its dividend and permission to buy back shares.

But the bank surprised many by choosing only the latter.

So, what does the bank’s decision mean for shareholders, and what does it say about the health of the bank?

Below are answers to those and some other questions that might be on the minds of investors and the public in the wake of the bank’s buyback announcement.

At what price will the bank buy back shares?

Jerome Dubrowski, a Bank of America spokesman, said the shares would be bought at whatever the market price is at the time they are repurchased. In other words, if you bought shares at $44 apiece years ago, don’t expect to see the bank buying them back at that price. Shares were going for about $12.80 Wednesday afternoon.

Can I sell back my shares directly to the bank?

Dubrowski declined to go into detail, beyond what the bank said in a press release, on how the shares will be repurchased. According to the press release, the shares might be repurchased on the open market or through “privately negotiated transactions” over the next four quarters.

Alan Knuckman, chief market strategist for Optionshop, an online futures broker, said it’s unlikely the bank will be buying back shares from the average shareholder. Rather, he said, the bank will likely buy back shares from institutional investors  he used the hypothetical example of Goldman Sachs  who have hundreds of thousands, if not millions, of shares.

Does Bank of America’s choice of a buyback over a dividend increase tell us anything about the health of the bank?

Steven Clark, an associate professor of finance at the University of North Carolina at Charlotte, says the buyback “tells us they’re sitting on a good bit of cash. Ultimately, it’s probably a good sign that they’re sort of generating this excess cash.”

Todd Hagerman, an analyst with Sterne, Agee & Leach, said the buyback is a sign of the times for the banking industry. “Effectively, we’re coming out of arguably one of the worst financial crises in the last 50 years in the United States,” he said. “It’s the best decision in the current times to buy back your shares when your stock is trading below tangible book value.”

Also, Hagerman said, buybacks are easier for a bank to halt, whereas a dividend increase “tends to be more permanent in nature.” Indeed, Bank of America, in its press release, said the repurchases could be suspended.

How much longer will Bank of America’s dividend be stuck at 1 cent?

Hagerman said there’s a strong likelihood that Bank of America’s dividend will increase next year. But, he said, the bank’s revenues need to stabilize. Hagerman also expects to see another share-buyback program from the bank next year.

Dubrowski declined to comment on the bank's 2014 capital plan. CEO Brian Moynihan, in a January fourth-quarter earnings call, said the bank is interested in giving capital back to shareholders. “Our intention is to return it,” he said during the call.

What’s better for shareholders, a buyback or a dividend increase?

Dividends are used by some shareholders as income, so a higher dividend means more income. But a buyback means fewer outstanding shares of a company’s stock, giving shareholders a larger stake in the company.

Clark said that while buybacks and dividends are both ways to return capital to shareholders, they are not one and the same. “In some sense, a buyback is preferable,” Clark said, “because presumably if the company is out repurchasing shares, those who want to liquidate their holdings can sell on the open market and generate cash that way.”

But when a dividend is increased, he said, all shareholders get the higher dividend. “The dividend, of course, is typically just treated as income and taxed as such,” he said.

Hagerman said dividends have “a more permanent connotation” to investors because of the perception that a buyback could be suspended at any time.

What’s the outlook for Bank of America’s stock?

Knuckman, in a March 8 report titled “BAC Back,” said Bank of America’s stock has "more room to recover.”

In 2008, the stock was going for roughly $40. While it’s far from that price, the stock is up from where it was just late last year, when it was around $10 per share. In 2012, Bank of America's stock was the best Dow Jones Industrial Average performer. The stock more than doubled in value last year, rising by 108.8 percent.

“From a trading standpoint, I think it’s been very attractive,” Knuckman said. “Bank of America’s stock has had an amazing resurgence. I’m looking for this to outpace the sector in general as a trading opportunity.”