The dark side of bank dividends
In April, U.S. banks dusted off the dividend again, a trick they’d mostly abandoned during the financial crisis. JPMorgan Chase plans an 8-cent-per-share hike. Wells Fargo’s will be 5 cents. Same for Morgan Stanley. Bank of America will raise its dividend a penny. Some might celebrate the move: The banks are back! But there’s more to it. In this fairly anemic economy, dividends are yet another strategic, if counterintuitive, hedge that won’t get our loved and loathed financial institutions lending again anytime soon.
Although good news for shareholders, the payouts don’t mask the reality that banks are still unstable. Executives are scared of looming regulatory schemes, such as the Brown-Vitter bill in the Senate, that could raise equity requirements to cushion the excessive debt of borrowing-prone banks. While earnings are up, balance sheets are deceptive. The big banks still rely heavily on income from the stock market, which overall has been stronger, and take in about $83 billion in subsidies. Their equity and cash reserves are a tiny fraction of their debt.
The banking sector certainly seemed more robust in the first quarter. Take JPMorgan Chase. It was solid enough to purchase $2.6 billion in stocks and $6 billion in buybacks, but its $25.12 billion in revenue was weaker than expected. The bank crowed that is the nation’s No. 1 Small Business Association lender, with a 10 percent increase from the same period last year. But commercial loan growth overall slowed to 1.2 percent in the first quarter compared with 3.6 percent in the first quarter, while consumer loans declined 4.2 percent from the same quarter a year earlier. Mortgage revenue was down 31 percent. According to one estimate, the bank’s $440 million annual subsidy paid 40 percent of its last dividend, which was about $1.1 billion.
That’s where dividends come in handy. As even a novice stock trader knows, they project an aura of confidence and stability. When shareholders are rewarded with swag, the banks signal confidence that operations are back to normal. Like clockwork, shortly after the banks’ announcements, analysts recommended that investors buy JPMorgan, Wells Fargo and other financial stocks.
Dividends help counter news reports of a system in transition. Sure, Citigroup may have sold off liabilities, and it’s still strong enough to spend $1 billion in share repurchases. Credit Suisse might have slimmed down, but it’s strong enough to consider issuing a dividend and is still a worthy competitor to UBS, which is downsizing its fixed income unit as it focuses on private banking. One analyst recently described the end of one-stop “financial supermarkets” that would make these big institutions “un-investable.”
Finally, dividends work for bankers who say they don’t want to hang onto cash or equity because it’s expensive. There’s no return when it sits idle. And when banks distribute dividends that eat away at their ability to pay back debt, bankers can claim they’re even more constrained. This puts them in the camp of those who say buffers will make banks less likely to lend because they’re too risky ‑ and they certainly can be, as the subprime mortgage and 1980s savings and loan crises revealed. But it’s hard to believe there aren’t more opportunities, given low interest rates. Holding onto less capital makes bankers who forgo financing for the more lucrative and speculative hedging look less like bad boys.
Banks seem to be ignoring any political arguments for bolstering balance sheets. Regulators under the Basel III accord, congressional efforts or even the Federal Reserve all could raise capital requirements to prevent future insolvencies. One way to get the government off their backs might have been to hold more on their balance sheets, not less. If it’s true that bond investors are demanding higher yields on bank debt and rating agencies may downgrade bank bonds by the year’s end, then shedding capital could be a defensive move against higher requirements. That could also be the case if capital ratios are boosted and transparency comes to the much-maligned derivatives market.
But bankers don’t seem to care. Dividends come from just a small fraction of capital allowances, so rewarding shareholders is ultimately a short-term strategy, not a long term, sustainable one. It might sound counterintuitive, but in a way it’s a hedge. It allays fear in the markets and is a nod to regulators that balance sheets still belong to the banks, even if units that cause problems often don’t even appear on the books.
In fact, balance sheets tell only part of the story. Economists Anat Admati and Martin Hellwig explain in The Bankers’ New Clothes that the accounting books often don’t reveal trouble. The reason JPMorgan and others impose risks on the financial system is that they own entities that aren’t even listed on balance sheets, so there isn’t a complete picture of the banks’ financials. The Enron units that caused problems were left off the balance sheets. The book value of equity is what appears on balance sheets, not even the market value.
Ultimately, if some banks end up in just the proprietary trading game, they don’t need as much capital. They just leverage. And since internal hedge funds are the banks’ golden calves, it wouldn’t be surprising if their days as commercial loan financers are numbered.
Special thanks to Harvard Business School professor Eugene Soltes.
PHOTO: U.S. coins are seen stacked in boxes inside a vault at a bank in Westminster, Colorado November 3, 2009. Picture taken November 3, 2009. REUTERS/Rick Wilking