The Fed’s 1-cent-a-share dividend cap
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.