Capital One Forced To Reduce Share Repurchases Due To One-Time $1.9 Billion Charge From The Tax Act

by Trefis Team
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Capital One (NYSE:COF) recently resubmitted its capital plan for 2017 to the Federal Reserve – six months after being singled out by the regulator as the only major bank holding company (BHC) to receive only a conditional approval for its capital return plan (see Fed Clears Capital Plans Of All U.S. Banks Subject To Stress Tests For The First Time In Seven Years). In light of the adverse impact the newly signed Tax Act will have on its deferred tax assets, the card-focused banking giant has reduced its share repurchase target under the current plan from the previously announced figure of $1.85 billion to $1 billion. The move makes sense, as the bank expects to incur a one-time charge of $1.9 billion to its earnings this quarter due to a write-off in its deferred tax assets. An optimistic capital return plan under these circumstances could result in the Fed rejecting the resubmitted capital plan and consequently curtailing all payouts over the first two quarters of 2018.

While the reduction in shareholder payout is bad news in the short run, we believe that the negative impact of this on the bank’s share value is more than made up for by the long term gains that will be achieved from the reduction in corporate tax rate to 21%. We are currently in the process of updating our price estimate for Capital One’s stock to factor in the impact of the lower payout as well as the improved tax regime.

See our full analysis for Capital One here

Capital One has a mixed history when it comes to paying dividends. The banking group paid 2.7 cents in quarterly dividends for years, until it revised it upwards to 37.5 cents in the last quarter of 2007 – only to slash it to 5 cents in early 2009 in the wake of the economic downturn. The 500% dividend hike in 2013 was largely unanticipated, and brought dividends to 30 cents a share. They remained at that level through 2014, but jumped to 40 cents in Q2 2015 and will remain at that level at least until Q2 2018.

The table below summarizes Capital One’s capital return figures for each year since 2007, and has been compiled using figures reported in annual reports:

As seen in the chart above, Capital One has been rather stingy with its capital returns. From 2007 through 2012, the bank paid less than $1.2 billion in total dividends – which works out to an average dividend payout of less than $150 million each year. Moreover, investors also had to contend with dilution in their holdings when the bank increased the number of its outstanding shares by 26% (from 460 billion shares at the end of Q4 2011 to 580 billion shares at the end of Q1 2012) to fund its acquisition of HSBC’s card business. It was only in 2013 that Capital One really began rewarding shareholders with cash – first hiking its dividends and then using proceeds from the sale of its Best Buy card portfolio to Citigroup to get a $1 billion share repurchase plan approved by the Fed. Although the bank maintained dividends at the same level over 2014, it sought to repurchase shares worth $2.5 billion that year. In 2015, the bank announced plans to repurchase $3.125 billion worth of its shares immediately after results for the 2015 stress tests were completed, and by the end of the year also received the Fed’s approval to repurchase an additional $300 million in shares over the first half of 2016 for total buybacks in excess of $3.4 billion. In the 2016 stress test cycle, the buyback figure was reduced to $2.5 billion, and after the latest modification to the 2017 plan, the figure is now down to just $1 billion.

Notably, Capital One has barely repurchased any shares over 2017, as its 10-Q SEC filing for Q3 2017 shows that total buybacks for the first nine-months of 2017 were just $236 million. As the bank disclosed in its recent SEC filing that it has repurchased “an immaterial amount of its common stock” under the 2017 capital plan, we expect total repurchases for the year to remain well below $300 million. Taken together with ~$770 million in common share dividends, this points to total payouts of just over $1 billion for full-year 2017 – the lowest figure since 2012. The figure should increase sharply in 2018, though, as the bank is likely to go ahead with repurchases of $1 billion over the first two quarters of 2018.

We represent dividend payouts in our analysis of Capital One in the form of an adjusted dividend payout rate, as shown in the chart below. You can understand how a change in the bank’s adjusted dividend payout affects its share value by making changes to the chart.

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