Opinion

Felix Salmon

The Fed’s 1-cent-a-share dividend cap

By Felix Salmon
March 23, 2011

Antony Currie wants a bit more clarity on why the Federal Reserve seems to be happy with Bank of America paying a dividend of 1 cent per quarter, but unhappy with a dividend of 5 cents per quarter. “It’s not clear,” he writes, “whether the Fed is worried about BofA’s core earnings falling short or about potential losses being higher than the bank projected, to pick a couple of possible concerns.”

My feeling is that the Fed’s logic wasn’t nearly that granular. There are basically three states that a bank can be in: it can pay no dividends at all; it can pay the minimum possible token dividend of 1 cent per quarter; or it can pay out a full and generous dividend. The Fed, in the wake of its latest stress tests, has determined that both Citigroup and Bank of America belong in the middle group. They can pay one cent a share, but no more — and in Citi’s case, they can only pay that much after doing a 1-for-10 reverse stock split and bringing the share price up above $40.

Paying a dividend is important from a symbolic perspective. It signals that the bank isn’t worried about insolvency, and it forces the bank to pay all dividends on preferred shares in full. If banks are paying dividends, that helps shore up confidence in the banking sector. If banks aren’t paying dividends, that keeps investors worried about what problems might lurk under the surface.

At the same time, the Fed has every interest in forcing banks to keep anything over one cent per share as precious capital, rather than sending it out to shareholders. The shareholders can’t do much with the money — not in this environment — while the system as a whole is clearly more robust the greater the amount of capital that banks manage to build up.

When Shira Ovide, then, characterizes the Fed’s stance towards BofA as “No Dividend for You,” she’s going too far. The Fed’s happy with BofA paying a dividend — indeed, astonishingly, BofA has been paying a dividend all along, with no objections from its top regulator. It just doesn’t want BofA paying out a dividend which is linked to profits. Not yet. For the time being, just like Citigroup, it’s being kept at that flat 1-cent-per-share level.

Update: I’ve heard a lot about mutual funds which are only allowed to invest in stocks which pay a dividend — sometimes with an explicit Berkshire Hathaway exception. Insofar as such funds exist, and I’m unclear on how prevalent they are, it makes a lot of sense to pay a de minimis dividend of one cent.

Comments
4 comments so far | RSS Comments RSS

What kind of a sad joke is it that dividends come before savings accounts?
It is said that dividends are the result of having nothing better to do with the money and the news headlines are full of complaints that banking reform will have a negative effect on bank earnings and thus higher fees to customers. All this talk and yet all we see in action is a rush to push money out the door to the wrong people at the wrong time for the wrong reasons.

Posted by TheTexadan | Report as abusive
 

Bank of America Corp. is A rated on negative watch from S&P (same as Citi, JP Morgan and Wells are AA- which is two notches higher). This rating even includes a bonus that they get for systemic importance and government support. Their S&P “market derived signal” is bbb-. Without government support, they may not even be investment grade, let alone one of the nations biggest corporate lenders (if you were a CFO, would you want BAC’s credit without govt support standing behind your corporate revolver?).

Bank of America didn’t earn their dividend. They lost money for both the quarter and the year ending Dec 31, 2010. They rely, more than most other banks, upon implicit and explicit support from the government to survive rather than an internal capital cushion.

How they have the nerve to think that they can distribute capital to shareholders is beyond me.

The one cent dividend does make sense for the bank to continue to have access to the market for raising preferred stock.

Posted by TurtleBay | Report as abusive
 

“(if you were a CFO, would you want BAC’s credit without govt support standing behind your corporate revolver?)”

Yes.

I work at a small bank never took goverment bail out money. BAC is one of our biggest competitors (so their demise would greatly boost our marketshare) and I can say with 100% confidence that BofA’s deposits are money good.

They have repaid their goverment funding with interest and now they should be allowed to resume their dividend payout at a low rate.

I will point out that paying a dividend restricts the future growth of a bank. Earnings retained as capital can be levered 10-1. Earnings paid out as a dividend cannot.

If you want to curb the growth of the evil mega-banks and promote the growth of Credit unions and Mutual savings banks (like mine), than allowing publicly traded banks to resume dividend payouts aids this effort at the margin.

All banks, every one depend on a an explicit govermental guarentee via the FDIC which can borrow directly from the U.S. Treasury.

Posted by y2kurtus | Report as abusive
 

“I can say with 100% confidence that BofA’s deposits are money good.”

I very specifically was talking about corporate revolvers, not FDIC insured deposits. Corporate revolvers are not FDIC insured because 1) they are liabilities of the corporation not assets and 2) they are well over the FDIC limit. Corporate revolvers are an interesting product because, somewhat like swaps, the credit risk goes both ways in the transaction. The banks rely on the corporates to repay their borrowings under the revolvers and the corporates count on the banks to be able to fund the undrawn balance of the revolver whenever the corporation needs liquid funds. Some borrowers had to find new lenders to replace Lehman when it wasn’t able to fund its revolver commitments.

“They have repaid their goverment funding with interest and now they should be allowed to resume their dividend payout at a low rate.”

Shouldn’t they be earning money to pay out a dividend? If the dividend is higher than earnings (it is since earnings are negative) then leverage goes up (assuming steady asset levels). This is easy math here. Also, lets not pretend that BAC’s GSE settlement wasn’t a transfer of value from the Govt to Bank of America.

“All banks, every one depend on a an explicit govermental guarentee via the FDIC which can borrow directly from the U.S. Treasury.”

Which is exactly why regulators Govt regulators get to approve or deny dividend policy.

“If you want to curb the growth of the evil mega-banks and promote the growth of Credit unions and Mutual savings banks (like mine)”

I work for a competing “evil mega-bank” so I can assure you that was not the motivation of my post.

Posted by TurtleBay | Report as abusive
 

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