With strong earnings for the past several years, banks have been accumulating capital at a faster rate than needed to support normal growth. Many major banks have been using their excess capital to buy back their shares.

By decreasing both capital and the number of shares outstanding, the buybacks have increased returns on equity and earnings per share. This, in turn, has helped fuel an enormous run-up in bank stock prices.

The buybacks have been highly popular with bank stock analysts. Analysts would rather see banks buy back shares than use their excess capital to support overly aggressive acquisition programs.

Intuitively, one has to question whether the buybacks make sense with bank stock price multiples at such high levels. It's not uncommon today for good bank stocks to be trading at more than two times book and 14 times earnings.

In times past, banks would have viewed a bull market in their shares as an opportunity to raise relatively cheap new capital. They subscribed to the time-tested notion that the key to success in business is to "buy low and sell high."

Not everyone is enamored with the buyback fad. A recent issue of "The Bank Stock Quarterly," published by M.A. Schapiro & Co., presents the case for why bank stock buyback programs might be ill-advised in today's climate.

"Try as we might," says the report, "we can't seem to fully convince ourselves that buybacks are really the optimal long-term use of 'excess' capital in today's market. It's not that we have a problem with buybacks in principle.

"Far from it. As outlets for excess capital, buybacks are almost always preferable to dividends and beat dumb acquisitions hands down. We simply think that buybacks today are being conducted without thorough consideration of alternative capital uses and without regard to stock price."

There are several reasons to be concerned about buyback programs. First, stock price multiples are likely to fall from their current levels, suggesting that it might be more advantageous to buy back shares later.

Second, buybacks artificially inflate the demand for the stock and thus its price. A turn of events that causes a bank to discontinue an aggressive buyback program (e.g., an increase in credit problems) could lead to a severe correction in the stock price.

Third, the notion that "excess" capital should be returned to shareholders requires that management use good judgment about the future. If there is a decent possibility that one or more unusually profitable investment opportunities will become available, the bank would be well advised to conserve some excess capital.

There are some risks in not buying back shares when the rest of the industry is doing it. A bank not buying its shares could have a lower relative stock price in the near term than its competitors who do.

The lower stock price could cause the bank to miss out on some acquisition opportunities. In the worst case, the bank might even become vulnerable to being acquired by a competitor with an artificially high stock price.

On the other hand, more than a few of the major banks owe their current good fortune to the fact that they were well capitalized in times past. Some needed the capital to survive a very difficult period. Others used the capital to make some fabulous deals on failed or failing institutions.

The consolidation in the financial services industry is far from over. Moreover, we will continue to experience business cycles. Both of these phenomena will weed out weak firms and create opportunities for the strong.

What do shareholders of a bank whose stock is selling at more than two times book want management to do? I suspect the answer will depend on the nature of the shareholder. A short-term investor will want the quick pop in the stock price that comes from a buyback program. A long-term investor will be more concerned about having capital available to take advantage of opportunities that arise.

Stock buybacks, used properly, can be very beneficial to shareholders. As is often the case in life, though, timing is everything and there can be too much of a good thing.

Mr. Isaac, former chairman of the Federal Deposit Insurance Corp., is chairman and chief executive of Secura Group, a financial services consulting firm headquartered in Washington, D.C.

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