There's no question that stock buybacks boost earnings and bolster return on equity, but with bank stocks at all time highs, some are starting to wonder if these programs really make sense.
"I don't think that many companies pay close attention to the economics of what they're doing," said Charles N. Cranmer, director of equity research at M.A. Schapiro & Co., New York, "Although buybacks are accretive to earnings, the higher the stock price goes, the less bang you get for your buck."
Analyst Carole S. Berger of Salomon Brothers Inc., New York, agreed that "clearly, the value of buybacks has diminished."
Three years ago, when most bank stocks were trading at about eight times estimated earnings, banking companies reaped a 50% to 60% internal rate of return for buybacks.
But now that the average regional bank is trading at 14.6 times 1997 earnings estimates, the internal rate of return has fallen to about 16% to 18%, Ms. Berger said.
"If the internal rate of return falls below the cost of capital, this is the wrong economic decision to make," she said, pointing to the alternative of paying a cash dividend in such a case.
Analyst Charles Wittmann of Wheat First Butcher Singer, Richmond, Va., said banks face a balancing act with repurchase programs these days. A banker agreed. "You're really walking a tightrope deciding when is the optimal time to buy," said Robert Savage Jr., strategic planning executive at CCB Financial Corp., Durham, N.C.
David S. Berry, research director at Keefe, Bruyette & Woods Inc., New York, took a broader view, saying: "Buybacks are not good in themselves, but part of the greater capital management program."
"It's not a matter of investing in your own stock price, but more of a corporate finance action," Mr. Berry said. But he acknowledged views that some banks have relied heavily on repurchases.
Bank of New York Co., for example, earned $1.08 billion in 1996, and bought back $1.05 billion in shares. That boosted return on equity to 22.5% in 1996 from 20% the previous year, but this level is not sustainable, some observers say.
Banks themselves are apparently the most zealous believers in stock buyback programs. Currently, 22 of the nation's 25 largest banks have them.
Together, U.S. banks repurchased $31.5 billion in 1996, accounting for 17.8% of the buybacks in all industries, according to Securities Data Co. In 1991, by contrast, banks bought back only $614 million of their shares.
Industry watchers say the trend is likely to continue, now that growth in both assets and loans is sluggish, and banks are under increased pressure to boost earnings.
And they may have their work cut out for them. Banks are on track to generate roughly $270 billion in excess capital over the next five years, according to the bank group at Credit Suisse First Boston. This capital overload would allow them to repurchase 35% to 40% of their stock in that time.
The fresh concerns about buybacks are in addition to long-standing questions about whether these programs are mainly an effort by managements to mark up their own stock. Mr. Berry insisted they are not.
"Buybacks are not a gimmick," he said. "They're not financial engineering to fake their ways to the numbers. They are much as part of the fundamentals as net interest margins and loan loss provisions."
But there is another question about buybacks-do they hinder a bank's capacity to make strategic investments in its franchise.
"Buybacks can help if your earning per share growth is below that of your peers," said Mr. Wittmann. "But you have to wonder. If you're trying to enhance your return on equity, why arent you putting it into other lines of business?"
Mr. Cranmer feels bankers should not only weigh chances for investment today, but also plan for future opportunities. "Analysts, and banks, sometimes confuse accounting results with economic returns," he said.
Still, he said, the trend toward repurchasing stock may continue to travel down the banking industry food chain.
"As the big companies sell at larger premiums through buybacks, the smaller companies become more vulnerable to acquisition," Mr. Cranmer said.
As smaller banks hustle to boost earnings growth and keep valuations in line with those of the bigger banks, more may begin to adopt the fashion to shield themselves from acquisition, even though they may have trouble maintaining liquidity in their shares.