Bank of America execs blew $93.6 billion. Here’s how they did it.

In several notes to clients this month, Odeon Capital Group analyst Dick Bove has pointed out that Bank of America’s big spending on stock buybacks over the past five years has been a waste for its shareholders, with the bank’s stock price declining slightly during that period.

The idea behind repurchasing shares on the open market is that they reduce a company’s share count and therefore boost earnings per share and support higher share prices over time. This doesn’t seem to be a bad idea, especially for a company such as Apple Inc. which has generated excess capital and has appeared to be firing on all cylinders for a long time. For a company that is continuing to expand its product and service offerings while maintaining high profitability, buybacks can be a blessing to shareholders.

But for banks, for which capital is the main ingredient of earnings power, a more careful approach might be in order. The data below show how buybacks haven’t helped the largest banks outperform the broad stock market over the past five years. And now, banks face the prospect of regulators raising their capital requirements by 20%, according to a Wall Street Journal report.

Before showing data for the 20 companies among the S&P 500 that have spent the most money on buybacks over the past five years, let’s take a look at how share repurchases are described in a misleading way by corporate executives — and by many analysts, for that matter. During Bank of America’s first-quarter earnings call on April 18, Chief Financial Officer Alastair Borthwick said the bank had “returned $12 billion in capital to shareholders” over the previous 12 months, according to a transcript provided by FactSet.

Borthwick was referring to buybacks and dividends combined. Neither item was a return of capital. In fact, Bove summed up the buybacks elegantly in a client note on June 9: “The money that the company uses to buy back the stock is simply given away to people who do not want to own the bank’s stock.”

It is also worth pointing out that the term “return of capital” actually means the return of investors’ own capital to them, which is commonly done by closed-end mutual funds, business-development companies and some real-estate investment trusts, for various reasons. Those distributions aren’t taxed and they lower an investor’s cost basis.

Dividends aren’t a return of capital, either, if they are sourced from a company’s earnings, as they have been for Bank of America.

One more thing for investors to think about is that large companies typically award newly issued shares to executives as part of their compensation. This dilutes the ownership stakes of nonexecutive shareholders. So some of the buybacks merely mitigate this dilution. An investor hopes to see the buybacks lower the share count, but there are some instances in which the count still increases.

Banks’ management teams and boards of directors have engaged in buybacks because they wish to boost earnings per share and returns on equity by shedding excess capital. But Bove made another industry-specific point in his June 9 note: “If the bank buys back stock it must sell assets that offer a return to do so; it lowers current earnings.” Buybacks can also hurt future earnings. Less capital can slow expansion, loan growth and profits.

According to Bove, Bank of America CEO Brian Moynihan, who took the top slot in 2010 and saw the bank through the difficult aftermath of its acquisition of Countrywide and Merrill Lynch in 2008, “is one of the brightest, most capable executives for operating a banking enterprise.”

But he questions Moynihan’s ability to manage the bank’s balance sheet. Bove expects that Bank of America will need to issue new common shares, in part because rising interest rates have reduced the value of its bond investments.

In a June 5 note, Bove wrote: “Mr. Moynihan indicated twice [during a recent presentation] that the bank has excess cash that apparently could not be invested profitably. Possibly he is unaware that the cost of deposits at the bank in [the first quarter of] 2023 was 1.38% while the yield in the Fed Funds market can be as high as 5.25%.” In other words, the bank could earn a high spread at little risk with overnight deposits with the Federal Reserve.

That is a very simple example, but if Bank of America had grown its loan book more quickly over recent years while focusing less on buybacks, it might not face the prospect of a near-term capital raise, which would dilute current shareholders’ stakes in the company and reduce earnings per share.

To look beyond banking, we sorted companies in the S&P 500 by total dollars spent on buybacks over the past five years (the past 40 reported fiscal quarters) through June 9, using data suppled by FactSet. It turns out 11 have seen prices increase more quickly than the index. With reinvested dividends, 12 have outperformed the index.

Click on the tickers for more about each company or index.

Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.

The four listed companies with negative five-year returns are three banks — Citigroup Inc. Wells Fargo & Co. and Bank of America — and Intel Inc.

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WATCH: Executives from failed banks face Senate questions on risk management

NEW YORK (AP) — Executives from two large U.S. banks that failed dramatically in March appeared in front of the Senate Banking Committee on Tuesday to respond to questions about why their banks went under and what regulators could have done to avoid the calamities.

Watch the hearing in the player above.

Along with questions about how these banks failed, senators used the hearing to also address executive pay and whether senior executives in the U.S. are being rewarded more for short-term gains — like rising stock prices — than for ensuring their companies’ long-term health.

Executives at Silicon Valley Bank and Signature Bank were paid millions of dollars over their tenures up until their banks failed, the bulk of the compensation coming in the form of company stock. That stock is now largely worthless but the CEOs still pocketed millions from the planned sales of their shares before the banks collapsed.

Sen. Sherrod Brown, the Democratic chair of the Senate Banking Committee, took aim at executive compensation to open the hearing.

“You were paying out bonuses until literally hours before regulators seized your assets. To people in Ohio and around the country, this feels sickeningly familiar,” Brown said. “To most Americans, a lack of Wall Street accountability tracks with their entire experience with our economy. Workers face consequences; executives ride off into the sunset.”

Silicon Valley Bank’s former CEO Greg Becker received compensation valued at roughly $9.9 million in 2022, and also sold stock in the company only a few weeks before it failed. Joseph DePaolo, CEO of Signature Bank, also sold stock in the company in the years leading up to its collapse.

WATCH: Fed raises rates again but signals a future pause amid banking sector uncertainty

DePaolo did not appear in front of the Senate on Tuesday due to health concerns; instead Signature’s co-founder and the bank’s president agreed to testify.

Becker used his testimony and answers to senators’ questions to say that Silicon Valley Bank was a victim of a confluence of factors, including a social media-driven bank run. His arguments seemed to make little headway with politicians on both sides of the aisle, who focused their questions on failures by the bank’s management to understand how rising interest rates could negatively impact their balance sheet.

“You say you took risk management seriously. I find it hard to believe that comment,” said Sen. Tim Scott, the ranking Republican on the committee.

Sen. John Kennedy, R-Louisiana, called the bank’s interest rate management “bone deep, to the marrow, stupid.”

The anger over CEO pay echoes that of roughly 15 years ago, when the 2008 financial crisis led to taxpayer-funded bailouts of major banks. The CEOs and high-level bankers still received millions in pay and bonuses, most notably at nearly failed insurance conglomerate American International Group.

“The recent bank failures prove yet again that banker compensation is at the core of causing banks to take too much risk, act irresponsibly if not recklessly, and blow themselves up,” said Dennis Kelleher, co-founder of Better Markets, which was founded after the Great Recession focused on financial industry reform.

Clawing back CEO pay has gained bipartisan attention despite the fierce divisions between the two political parties.

Four senators — two Democrats and two Republicans — have introduced legislation that would give the Federal Deposit Insurance Corporation authority to claw back any pay made to executives in the five years leading up to a bank’s failure.

READ MORE: First Republic Bank seized, sold to JPMorgan Chase in 2nd-biggest failure in U.S. history

The bill is sponsored by Elizabeth Warren, D-Ma., Josh Hawley, R-Mo., Catherine Cortez Masto, D-Nev. and Mike Braun, R-Ind. The White House, while not endorsing the specific bill, has called on Congress to pass laws to reform how bank CEOs are paid in the event of a failure.

Warren asked both Becker and Shay if they planned to return any of the compensation they received over the past few years to help cover some of the estimated $22.5 billion their banks’ failures cost the FDIC. Shay say he did not. Becker did not directly answer the question, and Warren responded she would “take that as a ‘no.’”

Warren called the responses “just plain wrong,” adding “if we don’t fix it, every CEO for these multibillion dollar banks will keep right on loading up on risks and blowing up banks and everybody else is going to have to pay for it.”

Executives at big companies also tend get most of their pay each year in company stock. That means CEOs and other insiders have much to gain if the company’s stock rises. And shareholders typically like it this way. The thought is that by tying a CEO’s compensation to the stock price, it better aligns their interests with shareholders.

But the executives also have a lot to gain if they can sell their stock before the share price takes a steep dive.

Since 2000, the Securities and Exchange Commission has given CEOs and other corporate insiders a way to defend themselves against charges that they bought or sold stock using information unavailable to others, an illegal practice known as insider trading.

The method, known as the 10b5-1 rule, lets insiders enter into written plans to buy and sell stock in the future. The goal was to let insiders make trades, but not when they have their hands on material information not available to the public.

Over the years, complaints have risen about insiders abusing some loopholes in the 10b5-1 rule. In December, the SEC announced amendments to close the loopholes.

In March, the Justice Department announced the first insider trading prosecution based exclusively on the use of 10b5-1 trading plans. It charged the CEO of a health care company in California with securities fraud for allegedly avoiding more than $12.5 million in losses by entering into two 10b5-1 trading plans while knowing the company’s then-largest customer might be terminating its contract.

The SEC also charged the CEO with insider trading after avoiding the 44 percent drop in the company’s stock price when it announced the customer had terminated the contract.

AP Business Writer Stan Choe contributed to this report from New York. AP Congressional Writer Stephen Groves contributed to this report from Washington.

Bank/Fin-Tech Agreements: Re-Assessment Required Given New Regulatory Guidance on Third-Party Servicing Agreements

Monday, June 12, 2023

On June 6, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Federal Reserve), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the Banking Agencies) released final interagency guidance on third-party relationships1 (Guidance).

Focused on risk management, the Guidance represents an effort by such agencies to ensure that there is consistency in third-party risk management guidance regardless of charter type and federal regulator. It also describes the obligations that apply to all banking organizations supervised by the Banking Agencies. Notably, the Guidance highlights that it is not "law" and "does not have the force and effect of law," a point that was raised in numerous comment letters received by the Banking Agencies in connection with the comment period as well as previous bank agency "guidance" related to certain banking activities, such as banks' relationship with providers of crypto-related products and services.

In terms of prescriptive requirements, the Guidance takes a well-honed view premised in a "risk-based approach," particularly with respect to operational, compliance, and strategic risks such relationships may pose for banking organizations. Specifically, the Guidance makes clear that each banking organization is required to "analyze the risks associated with each third-party relationship and . . . calibrate its risk management processes, commensurate with the banking organization's size, complexity, and risk profile and with the nature of its third-party relationships." With respect to fin tech relationships specifically, the Guidance states that banking organizations must understand how these agreements are structured in order to assess the levels and types of risks inherent in each such agreement through the use of a "sound methodology."

With respect to contractual relationships with third parties, the Guidance suggests board involvement on behalf of the banking organization. Specifically, "as part of its oversight responsibilities, the board of directors should be aware of and, as appropriate, may approve or delegate approval of contracts involving higher-risk activities." Related to this statement is the implicit point that boards of directors may be held responsible for failing to implement controls to ensure that third-party agreements involving "higher-risk activities" are reviewed at the board level. Therefore, banking organizations' boards must proactively ensure that appropriate "gating mechanisms" are implemented within the organization so that all necessary board review of such proposed arrangements occurs and is documented within the board minutes or otherwise.

Finally, the Banking Agencies noted that a determination was made "not to exclude any specific third-party relationships from the scope of the guidance [because it] is relevant to managing all third-party relationships." Relationships that certain commenters had argued should be exempt from such evaluative processes were those with affiliates and those with entities that are subject to some other form of regulation.

Coming on the heels of a recently published FDIC action against a New Jersey-chartered bank that is significantly involved in bank/fin tech partnerships, as well as the numerous recent actions taken by federal and state regulators against providers of crypto-related products and services (which are facing a unique set of challenges in maintaining relationships with US insured depository institutions), the adoption of the Guidance demonstrates banking regulators' keen interest in third-party relationships. While it is obvious that insured depository institutions will need to develop policies and procedures to implement these requirements, it is equally important for fin techs and other bank service providers to understand (and therefore anticipate) the types of questions that potential bank partners will raise about the provider's operations and overall risk profile. Developing appropriate, compliant policies and procedures and implementing them enterprise-wide will be critical to ensuring that such relationships withstand supervisory review of both the banking organization and the third-party provider that may be examined by a banking regulator in connection with the functions or operations such third-party performs on behalf of the bank.

1 The Guidance lists the following as examples of third-party relationships: outsourced services, use of independent consultants, referral arrangements, merchant payment processing services, services provided by affiliates and subsidiaries and joint ventures.