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Professional capital allocators using their own capital for financial engineering instead of productive growth


Source: The New York Times | Fair Game, February 18, 2017 column

Business Day

Yes, Mr. President, Banks Are Lending

Fair Game


President Trump ordered a review of financial regulations. Pool photo by Aude Guerrucci

This is the party line: Banks aren’t lending nowadays because the regulatory burden they face is too onerous. And that is hurting the economy and job creation.

Articulating this view, President Trump has vowed to slash financial regulations to fix the problem.

“Frankly, I have so many people, friends of mine, that have nice businesses and they can’t borrow money,” he said in early February. “They just can’t get any money because the banks just won’t let them borrow because of the rules and regulations in Dodd-Frank,” the Wall Street reform law of 2010.

Anecdotes can be compelling, of course. So many people with nice businesses who can’t borrow money. That sounds very bad.

But the actual figures tell a different story.


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Indeed, a look at recent bank results shows that lending among the big institutions is rising, not falling. In the fourth quarter of 2016, the most recent period, Bank of America, Citigroup, J. P. Morgan and Wells Fargo all reported increases in their average loan figures.

Some of these increases were greater than others, of course. J. P. Morgan’s average core loans were up 12 percent, year-over-year in the quarter, while at Citigroup loans grew by 1 percent. Wells Fargo’s loans rose by 6 percent, as did Bank of America’s, once you remove the dwindling Countrywide loan portfolio from the calculation.

So banks are not lending less.

Still, they could be doing more lending, says the veteran bank analyst Richard Bove, of Rafferty Capital Markets. And higher volumes of lending — of course, assuming the loans are appropriate — would help create jobs and fuel economic growth.

There is no doubt that Congress’ regulatory response to the financial crisis of 2008, which was largely fueled by reckless mortgage lending, tightened the rules for banks. Chief among them was a requirement that these institutions set aside greater amounts of capital to cover potential losses. That was justified, but it is crimping lending.

And there are other reasons these institutions are relatively restrained in their lending, Mr. Bove said.

“You cannot make the case that bank loans have not grown as a result of Dodd-Frank,” he said. “The only case you can make is that Dodd-Frank has been a depressant on bank loans because of the increase in capital ratios and the need to put more money into liquidity.”

Other drags on loan growth, Mr. Bove said, include rising interest rates, which reduce the value of the securities these banks hold. Increasing interest rates contributed to diminished common equity positions at a group of banks Mr. Bove follows.

Bank managers cannot control interest rates. But they can control the amount of dividends they pay out to shareholders, and the amount of stock they buy back in the open market. And generous distributions to shareholders by bank officials are a big factor in diminishing the money left over for making loans.

President Trump met with business leaders and Wall Street executives in the State Dining Room at the White House on Feb. 3. Al Drago/The New York Times

Stock buybacks and lush dividends come out of a bank’s retained earnings, also its source for increased lending. And Mr. Bove characterizes these payouts as financial engineering, pursued by bank executives interested in making their stocks perform better. He criticizes this practice, because while dividends and buybacks are good in the short-term, fewer loans will translate into reduced long-term earnings power at a bank.

“There’s no question that stock buybacks and high dividend payments eat into banks’ common equity and slow down their ability to make loans,” he said in an interview. “This also slows down the secular growth rate of the company.”

The amounts being paid out are considerable. During 2016, Wells Fargo returned $12.5 billion to shareholders through common stock dividends and share repurchases net of stock issued to employees. And in the most recent quarter, J. P. Morgan returned $3.8 billion to shareholders. That included $2.1 billion of net stock buybacks.

Representatives for the banks declined to comment for this column. But officials at these institutions often contend that buying back stock and paying rich dividends are ways of returning excess capital to their shareholders, who are entitled to that money.

At a presentation in 2014, for example, Marianne Lake, J. P. Morgan’s chief financial officer, described the bank’s capital allocation decisions: “The first priority is to support appropriate business growth and to provide a healthy dividend payout with the potential to increase over time,” she said.

Shareholders love their dividends and stock buybacks, of course, so none are likely to complain about these practices. Both help to keep share prices aloft as well.

But buying back shares and paying rich dividends to shareholders diminishes a bank’s common equity. And among 18 large banks that Mr. Bove follows, 14 showed declines in common equity in the fourth quarter of 2016 as a result of increased interest rates, buybacks and dividends. The combined decline in equity totaled almost $18 billion; in his view, that means the banks have lowered their ability to lend by $250 billion.

To be sure, none of these banks are paying out all of their excess capital in dividends or stock buybacks. And that leaves them with a much fatter cushion for bad times.

But Mr. Bove said that he had recently spoken with some bank executives who are considering paying out all the growth they report in retained earnings or common equity. “This would effectively negate any contribution that profits would make to retained earnings,” Mr. Bove wrote in a recent research note. “The combination of further interest rate increases and large buyback programs would accelerate the decline in common equity and the ability of banks to make loans.”

It is nothing new for the private sector to complain that regulations are cutting into their businesses. Given that the Dodd-Frank law runs to over 1,500 pages, undoubtedly some of its rules could be eliminated without bringing back reckless lending. This is especially true for smaller institutions. One of Dodd-Frank’s bigger errors was to require smaller banks that had played no role in the crisis to ramp up their compliance duties as well. This was unfair and, yes, burdensome.

Mr. Bove said he believes that some of the regulations should be reversed, but the elements he cited are not those that Republicans are focusing on.

“The Republicans in the House and Senate cannot even agree with each other as to what should be deregulated,” he pointed out in a recent research note. “In the Senate, they want a big-government approach to change the structure of the industry. In the House, there is a desire to get rid of irritating amendments to Dodd-Frank. Nothing is going to get done.”

If Mr. Bove is right, that might be a good outcome. But this much is clear: The next time someone tells you that a wide swath of financial regulations needs to be reversed because they are crimping bank lending, you can tell them they’ve got only part of the story.


A version of this article appears in print on February 19, 2017, on Page BU1 of the New York edition with the headline: Yes, Mr. President, Banks Are Lending.


© 2017 The New York Times Company


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