Dividend Policies of Global Banks Need a Fresh Look

As a number of big U.S. banks scramble to raise billions in fresh equity to repair balance sheets ravaged by asset write-downs, necessary increases in credit reserves and blind adherence to outmoded dividend policies, one question begs asking: When will these banks’ boards of directors throttle the dividend spigot?

The May 28, 2008 Wall Street Journal carried a Holman W. Jenkins, Jr. Op-Ed (“Dividend Dummies?”) endorsing payment of hefty dividends.  Holman’s arguments, while interesting intellectually, ignore the realities of today’s global market where banks (commercial and investment) play key roles as creators/providers of money and raisers of capital.  Competition is intense, and clients increasingly ask banks to employ their balance sheets to help execute transactions. 

Students of Corporate Finance 101, and survivors of the Great Depression, know balance sheet strength comes from a healthy mix of equity and debt, and balance sheet integrity is critical to maintenance of depositor confidence and prudent bank conduct.  Finance students also know the cheapest form of equity is retained earnings (the well from which dividends spout), and primary equity capital markets are not always receptive, or even open at all, to new equity offerings.

The sudden, sickening collapse and disappearance of the 85-year old investment bank Bear Stearns was a stark reminder of investor (and depositor) fickleness, and it transported us back to the early 1930s when runs on banks were commonplace.  No wonder many of the architecturally admired buildings erected in that era have a fortress-like look trumpeting a simple message to depositors: “Your money is safe here.”  The public’s memory of bank runs is real and long lasting.  Trust is hard to earn and easy to lose.

A financial institution’s balance sheet is its “business card” and the bedrock supporting its entire range of activities, which for Citigroup takes place in over 100 countries.  Surely mistakes will occur, loans will go delinquent and deals will need restructuring.  A healthy dose of equity, however, provides the cushion to absorb such unwelcome but expected events.

It is time for boards like Citigroup’s to consider a more enlightened 21^st century dividend policy that acknowledges the inherent risks of a global bank business model. 

Recommendation to all bank directors: pay a modest quarterly dividend of 5¢ per share and commit annually to consider a year-end special dividend after receipt of audited results.  What better time to adopt a fresh policy than now with the lessons of lack of respect for balance sheet integrity still so fresh?  Seasoned equity analysts will embrace such a bold initiative, as will bank regulators, credit ratings agencies and investors.

Bruce S. Foerster

Miami, Florida

May 2008