What Does JPMorgan’s Plan To Replace Share Buybacks With Special Dividend Mean For Investors?

At a recent conference, JPMorgan (NYSE:JPM) chief Jamie Dimon said that the bank is exploring the option of returning some cash to investors in the form of a special dividend. ^[1] The reason for this is the surge in the banking giant’s share price since the U.S. presidential election. JPMorgan’s shares are currently trading at an all-time high of almost $84 – a figure that is 30% ahead of the book value of $63.79 and almost 65% higher than the tangible book value of $51.23 at the end of Q3 2016. This makes the bank’s current share repurchase plan a relatively unattractive payout method, lending support to a one-time special dividend payout.

It should be noted that the bank’s capital return plan for 2016 as approved by the Federal Reserve was focused considerably on share buybacks (see JPMorgan’s 2016 Capital Plan Will See Investors Receiving $17 Billion Over Next Four Quarters). In this article, we detail how JPMorgan’s decision to pay a one-time dividend as opposed to sticking to its current share repurchase plan affects the total cash received by investors and also the number of the bank’s outstanding shares.

See our full analysis for JPMorgan Chase here

We are currently in the process of updating our $65 price estimate for JPMorgan’s stock to account for the gains expected across the banking sector.

Over the years, JPMorgan has positioned itself as a bank with a fairly liberal capital return policy, as it returned almost 60% of its retained earnings to shareholders over 2006-15 in the form of dividends and share repurchases despite the adverse impact of the economic downturn on payouts during 2008-10. Earlier this year, the bank announced plans to return a record $17 billion to investors over Q3 2016 – Q2 2017 as it sailed through the Fed’s annual stress test for banks this year. This payout included dividends of roughly $6.4 billions and a new $10.6-billion share repurchase program. In the third quarter of 2016, JPMorgan repurchased shares worth $2.3 billion – leaving authorization in place to buy shares worth $8.3 billion over the three-quarter period from Q4 2016 through Q2 2017.

But with JPMorgan’s share price skyrocketing over recent weeks to an all-time high, the bank has had to rethink its share repurchase plan. This is particularly true given the considerable premium the current share price represents to the actual book value of the shares. Now, JPMorgan can resort to the option of a special dividend to circumvent the problem caused by elevated share prices to its buyback plan. But this option comes with an important caveat: the Fed’s rules limit such one-time dividends to 1% of a bank’s Tier 1 capital. As JPMorgan reported Tier 1 capital of $180.9 billion at the end of Q3 2016, the bank can only distribute a maximum of $1.8 billion as a special dividend to shareholders. This would mean that it still has to repurchase shares worth $6.5 billion before Q2 2017 to completely use up the $8.3 billion in cash it is authorized to return.

Additionally, there is another factor that could complicate things for JPMorgan. The Fed is currently working on a proposal to reduce the limit on special dividends from 1% to 0.25%. ^[2] If the new limit is adopted, then all banks will have to adhere to it from next April – leaving JPMorgan with little more than three months to put into action a plan to return $1.8 billion through this route. In case of a delay, a special dividend would be restricted to just $450 million.

The table below summarizes the overall impact on cash payouts to investors and the outstanding shares in three different scenarios: 1) JPMorgan sticks to current share repurchase plan; 2) JPMorgan announces a $1.8 billion special dividend; and 3) JPMorgan announces a $450 million special dividend.

• Spl Div = Special Dividend
• Ordinary dividend per share calculated as 48 cents per quarter for 3 quarters

As seen in the table above, a one-time special dividend of $1.8 billion represents a win-win situation for JPMorgan and investors in terms of paying out cash in the most economical way given regulatory restrictions. The reason for this is primarily the negligible impact of share repurchases on the number of outstanding shares for JPMorgan – a situation that is exacerbated by the unusually high share price prevalent now. Additionally, we believe that JPMorgan’s share price is above its intrinsic value, as the equity market is driving gains for the banking industry from Donald Trump’s victory, and it is only a matter of time before prices normalize somewhat. This also tips the scale in favor of the special dividend option in the near future, as JPMorgan can return to repurchasing shares if and when prices settle down.

We represent dividend payouts in our analysis of JPMorgan Chase in the form of an adjusted dividend payout ratio, as shown in the chart below. You can see how a change in the bank’s policy of returning cash to investors affects its share price by making changes here.

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1. JPMorgan CEO says bank may look to pay special dividend, Reuters, Dec 6 2016 [↩]
2. JPMorgan’s Race Against the Fed, Bloomberg Gadfly, Dec 6 2016 [↩]