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With the stock market at all time highs, corporations are in a mad rush to buyback more shares. Corporations just cannot get enough of their own shares, no matter how mispriced they are.
The means banks choose to finance buybacks and pay for dividend hikes is irrelevant to most (the unthinking crowd), but amusing or scary to others.
Zombie Banking System Progression
Reuters writer David Henry explains U.S. Banks' Buybacks, Dividends may be no Reason for Shareholder Celebrations.
Big U.S. banks, including JPMorgan Chase & Co (JPM) and Citigroup Inc (C), are expected to win Federal Reserve backing on Wednesday to buy back more shares and increase their dividends in the coming year, but the approvals may be as much about the institutions’ financial engineering as any improvement in their health.Can't Get Enough
Much of the money for buybacks and higher dividends is coming from the banks issuing securities known as preferred shares. These shares are a type of equity that pays regular, relatively high dividends. To investors they look a lot like bonds that pay interest. But for regulators, preferred shares serve as a cushion against any future losses, in part because they never have to be repaid.
Critics of the strategy question how sustainable it is, as banks essentially take money from one set of investors and give it to another, and at an added cost.
Issuing preferred shares to pay for common share dividends and buybacks is a symptom of a "zombie banking system," said veteran banking analyst David Hendler of independent research firm Viola Risk Advisors.
"Banks should be building capital from normal lending and trading profits, but their operating income is terrible," he added.
Selling preferred shares to boost payouts to common shareholders can't go on forever without banks improving their results enough to boost their capital levels significantly.
INVESTORS HOLD THEIR NOSES
Buyers of preferred shares are attracted by the high dividends. They take a sizeable risk because often the bank will never redeem the shares, and they can only be sold to other investors. Dividends may also be suspended on the securities.
"Out of necessity, they hold their noses and buy it," Viola's Hendler said. The shares wouldn't have the same appeal if yields on bank debt weren't so low, he added.
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What can possibly go wrong here?
Mike "Mish" Shedlock