Bank Capital Allocation: Explaining Buybacks

A Simple Explanation of Repurchasing Shares and How Price, Valuation, & Earnings Growth Shape the Equation

I was chatting with a friend (and must follow on X - shaskell12) about capital allocation in the banking industry, and it got me thinking. There’s really no bank capital allocation bible for boards or execs or people wanting to become “great” at the skill.

So, let’s take a stab at one of the main ways execs can “allocate capital” at a bank, stock buybacks.

The Buyback Cheer

“Today, the Board is pleased to announce a share repurchase program…”

It’s a line every investor knows by heart. Analysts cheer. Stock prices nudge higher. And executives pat themselves on the back.

But beneath the applause lies a nuanced and often misunderstood game of trade-offs. Done right, buybacks can supercharge value creation. Done wrong, they quietly erode shareholder wealth.

What follows is my $0.02 on Tangible Book Value Per Share (TBVPS), why buying stock at a premium dilutes value, why buying at a discount builds it, and how earnings per share (EPS) growth impacts outcomes. If you’re a board member, capital allocator, or just here to learn, this is foundational knowledge for mastering the playbook.

What Do You Do with Capital?

Warren Buffett’s mantra is clear: A CEO’s most important job is capital allocation.

In banking, this is rarely taught and often overlooked. The best executives understand capital allocation is their edge. As a bank, you can: Grow organically (make loans, raise deposits), expand inorganically (M&A, leverage, borrowing), adjust dividends up or down, optimize the balance sheet (leverage or de-leverage), or sell/repurchase shares.

Simple, right? Not quite. The real insight comes in understanding how these levers interact, especially when one—like buybacks—can both create and destroy value depending on execution.

And in chatting with another friend (and another must follow on X - Departed) even though I didn’t want to get into the capital required to do buybacks, ignoring it all together would have been doing you all a disservice. So first, on CET1.

How Much CET1 is Needed to Do Buybacks?

CET1, or Common Equity Tier 1, is the cornerstone of a bank's financial strength, reflecting its highest quality capital. It includes common stock, retained earnings, and other reserves, minus deductions like goodwill. Under Basel III, CET1 typically includes Accumulated Other Comprehensive Income (AOCI), capturing unrealized gains and losses from available-for-sale securities and hedges. However, in the U.S., smaller banks can exclude AOCI to avoid capital volatility, while large banks must include it, ensuring their CET1 reflects market realities. Notably and obviously HTM securities (hide it in the accounting closet) do not find its way into CET1 beyond the point when it was originally tucked away.

DFAST, the Dodd-Frank Act Stress Testing framework, puts banks to the test under harsh economic scenarios to ensure they maintain strong capital buffers. At the heart of DFAST is the CET1 ratio—a critical gauge of a bank's resilience. With a minimum regulatory threshold of 4.5%, this ratio measures CET1 capital against risk-weighted assets. Risk weighted assets for the new bank person being the capital charged against things like US Treasuries (0% RW) vs. FNMA Mortgage Backeds (20% RW) vs. Residential Mortgage Loans (50% RW) vs. Commercial Real Estate (100% RW) - all with an eye on credit risk.

The main CET1 point being you need a minimum of 4.5%. Then you need a cushion correspondent to the amount of capital you’d lose in a stressed scenario. Then most prudent managers include a buffer or cushion of 1% or 1.5%. In today’s day and age, a CET1 ratio of 10% or lower is a red flag to regulators and will preclude you from growing (you likely have to raise or do a CRT, etc) and it will certainly preclude you from doing buybacks.

People like me can look at a small bank’s CET1 and determine if they’re able to grow or not based on this. And to prove the strength of the system, below is from the 2024 DFAST results showing STRESSED CET1 ratios for big banks in the US. JPM is the pinnacle.

Tangible Book Value: The Foundation

From CET1 “clearing” you to do buybacks, we’ll now head back to the foundation of the math around doing buybacks. First we define what TBV is and then get into mechanics.

Start with this:

• Tangible Book Value (TBV) is what’s left for shareholders after liabilities and intangible assets (e.g., goodwill) are stripped away from total assets. Think of it as core liquidation value.

• TBVPS = TBV ÷ Shares Outstanding.

Mechanically, when you repurchase shares, you’re spending cash (a TBV component) to reduce share count. The result? TBVPS increases or decreases depending on whether the buyback price is above or below TBVPS. Sounds simple right? Let’s play around with the core variables to see what this looks like in practice.

The Bank Setup

Here’s the hypothetical bank we’ll use to illustrate:

• Stock Price: $10

• Base EPS: $1

• P/E Ratio: 10

• Next Year Earnings Growth: 10%

• Next Year Earnings/EPS: $110M / $1.10

• Shares Outstanding: 100M

• Market Cap: $1B

• TBV / TBVPS: $700M / $7

• Price-to-TBV Ratio (P/TBV): 143%

• ROTCE (Return on Tangible Common Equity): 14.2%

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Premium Buybacks: Paying $10 for $7

Let’s assume the bank announces a 10% buyback—repurchasing 10M shares at $10, a 143% premium to TBV. The math:

• Cost of Buyback: $10 x 10M = $100M.

• Post-Buyback TBV: $700M - $100M = $600M.

• Post-Buyback Share Count: 100M - 10M = 90M.

• New TBVPS: $600M ÷ 90M = $6.67.

Result? TBVPS drops from $7 to $6.67. Why? The bank paid $10 for something worth $7. That’s not value creation; it’s dilution.

In investing terms, this violates the golden rule: “Buy low, sell high.” Instead, you’re buying high and shrinking shareholder value. This is why the golden rule is to not purchase back your shares at large premiums. In this case even a 143% of TBV creates dilution to the rest of the remaining shareholders.

Discount Buybacks: Paying $5 for $7

Now imagine the same bank trades at $5—a 71% discount to TBV. It announces the same 10% buyback. The math changes:

• Cost of Buyback: $5 x 10M = $50M.

• Post-Buyback TBV: $700M - $50M = $650M.

• Post-Buyback Share Count: 100M - 10M = 90M.

• New TBVPS: $650M ÷ 90M = $7.22.

This time, TBVPS rises from $7 to $7.22. Why? The bank paid $5 for something worth $7. That’s value creation, plain and simple.

This is the textbook example of “buy low, sell high.” And it’s why undervalued buybacks should make any shareholder smile. Buying back shares at a discount create accretion to the remaining shareholders. This is another reason why recently converted thrifts tend to be safe plays (Peter Lynch first wrote about this) because with the excess capital issued at a discount, they can quickly buy back shares accreting TBVPS quickly.

What Else Do Buybacks Do?

Reducing shares outstanding does more than just change TBVPS—it ripples through other key metrics.

First up: Earnings Per Share (EPS).

In our example, the bank was set to grow earnings from $100 million to $110 million next year. With 100 million shares outstanding, EPS would have increased from $1 to $1.10—a solid 10% growth.

But with a buyback reducing share count to 90 million? That same $110 million now delivers an EPS of $1.22. The result? A 22% EPS growth rate—more than double what it would have been without the buyback. In this way buybacks are another lever used to juice short term EPS growth numbers.

Next, let’s talk about ROTCE (Return on Tangible Common Equity).

Before the buyback, forward ROTCE stood at 15.7% ($110 million in earnings ÷ $700 million in tangible common equity). Post-buyback, the number jumps to 18.3%—a significant boost.

The reality is a bit messier because Tangible Book Value (TBV) is likely to grow over time, as retained earnings or dividends play their roles in TBV growth along with the shrinking due to the buyback. But even with these variables, the core idea holds that buybacks have a powerful impact on ROTCE.

And remember executive compensation agreements often tie bonuses to metrics like ROTCE and EPS growth. This creates a strong incentive for executives to use buybacks strategically—not just to legitimately create value but to “massage” the numbers when needed. Don’t hate the player, hate the game.

The best leaders? They understand the game, know how to play it, and ensure that buybacks deliver real value alongside the optics. The not-so-great ones? They just nudge the metrics and hope no one notices the lack of substance.

Would Doing Nothing Be Better?

Let me attempt to break this down simply.

If the bank had done nothing—absolutely nothing—here’s what would’ve happened:

Earnings would rise to $110 million. Tangible Book Value (TBV) would grow from $700 million to $810 million, taking TBVPS from $7 to $8.10.

Now, compare that to the scenario of a premium buyback at 143% of TBV:

• TBV drops to $600 million.

• Shares outstanding shrink to 90 million.

• TBVPS falls to $6.67.

Sure, EPS increases from $1.10 to $1.22 thanks to fewer shares, but here’s the kicker: even after factoring in retained earnings, pro forma TBVPS only climbs to $7.89 by year-end ($6.67 TBVPS + $1.22 EPS).

The result? In the short run, shareholders would’ve been better off if the bank had simply held onto its cash and avoided the premium buyback altogether.

This isn’t rocket science—it’s fundamental math. Paying a premium above TBV creates a drag that’s hard to recover from. Simple, but crucial. This is more or less the foundation of deciding whether or not to buy back shares (if you can).

Earnings Growth: The Game-Changer

But what happens if the banks’ core performance is changing? And this came about through another chat with a friend worth following (KSKInvestors) about earnings growth and their impact on the buyback equation of “should I or shouldn’t I” buy back stock at premium valuations.

Bank earnings aren’t static—they’re always in motion. Right now, across the industry, EPS estimates are improving. Why? Because most banks—especially those deeply entrenched in traditional lending—are 70% to 80% net interest income driven and short rates coming down should mean improvements in NIM and NII going forward. Note to bank investors: steeper yield curves are good for banks.

Why? Because they earn their keep on the spread: the difference between what they pay depositors and what they earn on loans or assets. And this spread? It’s at the mercy of the interest rate curve, the absolute level of rates, and credit spreads.

In today’s environment, with rates expected to decline on the short end, the outcome is clear: net interest income should expand, fueling EPS growth for many banks.

So, how does this change the buyback equation?

It’s simple. Earnings growth amplifies the impacts of buybacks.

When earnings growth is strong, buybacks at a premium to TBV become less painful. A premium buyback at 143% of TBV that might have taken over a year to "earn back" suddenly becomes palatable in six months. This is a big concept to understand.

But that’s not all. Higher earnings growth also supercharges ROTCE, accelerating the bank’s ability to generate organic capital. This creates a flywheel effect: rising earnings, increasing ROTCE, and more capital to deploy wisely.

When the machine works, it doesn’t just hum—it roars.

Let’s put this into perspective.

In our example, “doing nothing” resulted in a TBVPS of $8.10 after one year, starting from $7. That’s the baseline.

Now, when you buy back shares at higher Price/TBV ratios, you’re taking on a bet: that future earnings growth will make up for the dilution. The math only works if the result eventually beats $8.10. If your strategy delivers less than $8.10, you’ve made a suboptimal choice—at least in the short run.

But here’s the twist: in the long run, the picture can change. The bank with a lower starting TBVPS but higher EPS growth can eventually overtake the do-nothing bank. The catch? It might take 2, 3, even 5 years for that crossover to happen. But as you’ve just learned that’s contingent on interest rates, earnings, etc.

And while that’s not inherently bad, here’s the key lesson: Murphy’s Law is always lurking. Anything that can go wrong—rates, credit spreads, economic downturns—typically will go wrong.

That’s why shorter earn-back periods or faster lapses of the do-nothing scenario are better. Tighter timelines reduce the risk that the future won’t cooperate with your best laid plans.

And what happens if (gasp) your bank is actually expecting to see earnings decline? Don’t worry, I got you covered. See below for the impact of buybacks at different prices and levels of earnings contraction (and growth).

The takeaway here would for me would be that something like buying back at 125% of TBV with 20% earnings growth on the horizon can actually be a good idea. While buying back at 125% of TBV with earnings contraction on the horizon is not so good an idea. Simple, but hopefully this gives you new capital allocators some context.

Another takeaway is that buying back shares at discounted prices can absolve many earnings growth sins. Many many earnings growth sins. And yet another reminder why buying recently converted thrifts typically works (excess capital + buybacks at big discounts = wins).

Buying back at big premiums to TBV require big earnings growth and big ROTCEs. Or an executive that really has nothing better to do with their capital and is accruing too much (more on that later).

And the last takeaway is to run the numbers for yourself.

Buybacks vs. Other Options

Buybacks are just a tool—nothing more, nothing less. Like any tool, they can be used wisely or misused entirely. The key is to approach them with no emotional bias—no reflexive preference for or against.

Here’s a cautionary tale: in fast-growing tech companies, buybacks are often used for all the wrong reasons. Picture this: huge amounts of Share-Based Compensation (SBC) being issued to employees, diluting shareholders. Instead of addressing the root cause, the company initiates buybacks to mask the dilution by reducing share count. The result? A spinning wheel that shifts value from shareholders to employees. A neat little racket—if you’re on the receiving end.

Thankfully, banks are typically more disciplined. But even so, they face tough choices. Imagine this scenario:

• The bank has an opportunity to pursue an M&A deal that’s 15% dilutive to TBVPS but promises 20% EPS accretion. Should they go for it or opt for buybacks instead?

• Or maybe the choice is between buybacks and investing in a digital transformation or a non-interest income vertical—projects that require a 5-6 year J-curves to deliver returns.

• Or should the capital be deployed to fuel organic growth in adjacent markets, even if margins are thin?

These aren’t easy decisions.

Here’s how I’d approach it: start with the fundamentals. Look at the Revenue Per Share (RPS), EPS, and TBVPS implications of each option—not just today, but tomorrow and years into the future. Then layer in your macro assumptions: how would a shift in interest rates, credit spreads, or the broader economy impact each strategy? What happens if credit goes bad?

This kind of analysis separates good decisions from great ones. And any investment banker worth their salt will have strong opinions—and the models to back them up. The best don’t just guess; they build a clear, data-driven roadmap to guide the way forward.

Why Buy Back at High Valuations?

So, what would cause a bank with a mega valuation of 400% TBV do a buyback?

Well one, if the bank has exceptional earnings growth prospects—driven by rising profitability or operational leverage—a buyback, even at this lofty valuation, could boost Earnings Per Share (EPS) and justify the high multiple over time. The math works if future growth in EPS and Return on Tangible Common Equity (ROTCE) is strong enough to earn back the premium quickly.

Sometimes, the bank’s high valuation reflects its unique position in the market—perhaps as a niche player in digital banking or a specialty lender with few competitors. In such cases, a buyback can signal confidence to investors, especially if the bank has excess capital and no better opportunities for M&A, organic growth, or reinvestment. It shows discipline, reinforces its valuation story, and aligns with shareholder interests.

In other scenarios, the bank might feel pressure from activist investors or large shareholders to deliver immediate returns, making a buyback the best way to deploy surplus capital—even at a high price. Alternatively, management might believe the valuation is structural, not cyclical—driven by a high-margin, high-growth model that justifies a steep premium.

The move also makes sense if the bank boasts exceptionally high ROTCE—say, 25% or more. In such cases, keeping capital idle or funneling it into low-return initiatives could dilute returns. A buyback, though expensive, can maintain the momentum of high ROTCE and create a flywheel effect: driving EPS growth, retaining investor confidence, and reinforcing the bank’s premium valuation. But this strategy isn’t without risk. A buyback at 400% of TBV is a bold bet, and if growth falters, it could backfire, leaving shareholders questioning whether the price was worth it.

The Final Takeaway: Be Like Water

Buffett said, “Be greedy when others are fearful.” And it’s true buybacks work best when shares are undervalued and multiples are trash.

But to execute well, you need three things:

1. A clear view of earnings growth.

2. A tight understanding of your alternatives.

3. A clear and unbiased mind

In short channel your inner Bruce Lee, “Empty your mind, be formless, shapeless – like water. Now you put water in a cup, it becomes the cup; you put water into a bottle, it becomes the bottle; you put it in a teapot, it becomes the teapot. Now water can flow, or it can crash. Be water, my friend.”

So the next time you’re wondering about buybacks, empty your mind, review your options, and be water my friend.

Until next time,

Victaurs

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