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F ederal R eser v e Bank
OF DALLAS
WILLIAM H. WALLACE

DALLAS. TEXAS 75222

F IR S T V IC E P R E S ID E N T

December 12, 1985
C i r c u l a r 85-146

TO:

The Chief Executive O f f i c e r a t a l l
member banks, s t a t e member banks
and o t h e r s concerned in the
Eleventh Federal Reserve D i s t r i c t
SUBJECT
P o l ic y statement on payment o f cash dividends
DETAILS

The Board of Governors o f the Federal Reserve System has issue d a
p o l i c y s ta t e m e n t on the payment o f cash divide nd s by s t a t e member banks and
bank holdi ng companies t h a t are e x p e r ie n c in g f i n a n c i a l d i f f i c u l t i e s .
This p o l i c y is meant to r e i n f o r c e p r u d e n t i a l c o n s i d e r a t i o n s and to
encourage management to c o n t i n u a l l y review dividend p o l i c i e s in l i g h t of an
o r g a n i z a t i o n ' s f i n a n c i a l c o n d i t i o n , compliance with s u p e r v i s o r y g u i d e l i n e s on
c a p i t a l adequacy, and f u t u r e growth plans and p r o s p e c t s .
ATTACHM
ENTS
The Board's pres s r e l e a s e and p o l i c y s t a t e m e n t a r e a t t a c h e d .
M R INFORM
OE
ATION
For f u r t h e r in f o r m a ti o n , p le a s e c o n t a c t David Dixon a t (214) 651-6228
or the fo ll ow in g S u pe rvi si on and Regulation pe rs o nn el :
S t a t e Member Banks:

Marvin C. McCoy (214) 651-6657

Bank Holding Companies:

Richard J . Burda (214) 651-6472
Sincerely yours,

For additional copies of any circular please contact the Public Affairs Department at (214) 651-6289. Banks and others are
encouraged to use the following incoming WATS numbers in contacting this Bank (800) 442-7140 (intrastate) and (800)
527-9200 (interstate).

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

FEDERAL RESERVE press release
For Immediate r e l e a s e

. ,r t.
^
November 14, 1985

The Federal Reserve Board today issued a p o lic y statement on the
payment of cash dividends by s t a t e member banks and bank holding companies
th a t are experiencing f in a n c ia l d i f f i c u l t i e s .
The p o l i c y statement, which i s part of a program t o strengthen
supervis io n of banking operatio ns, addresses the fo llow in g pr a c tic es of
supervisory concern by i n s t i t u t i o n s that are experiencing earnings
weaknesses, other se r io u s problems, or th at

have inadequate c a p ita l :

—

th e payment of dividends not covered by earnings,

—

th e payment of dividends from

borrowed funds, and

—

t h e payment of dividends from

unusual or nonrecurring gain s,

such as th e s a l e of property or other a s s e t s .
I t 1s the Federal Reserve's view th at an organization experiencing
earnings weaknesses or other fi n a n c i a l pressures should not maintain a le v e l
of cash dividends th at exceeds i t s net income, th a t i s in c o n s i s t e n t with the
o r g a n iz a t io n 's c a p it a l p o s i t i o n , or th at can only be funded in ways that may
weaken th e o r g a n iz a tio n 's fin a n c ia l h e a lth .

In some i n s t a n c e s , i t may be

appropriate t o e lim in a te cash dividends a l t o g e t h e r .
The p o li c y statement reads in part:
"A fundamental principal underlying the Federal Reserve's
s upervis io n and regu la tion of bank holding companies i s th at bank holding
companies should ser ve as a source of managerial and f in a n c ia l strength
t o t h e i r subsidiary banks. The Board b e l i e v e s , t h e r e f o r e , th at a bank
holding company should not maintain a l e v e l of cash dividends t o i t s
shareholders th at places undue pressure on the ca p ita l of bank s u b s id ia r ie s
or th a t can be funded only through add ition al borrowings or other arrange­
ments th at may undermine the bank holding company's a b i l i t y t o serve as a

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-2-

s ou rce of s t r e n g t h . Thus, f o r example, i f a major s u b s i d i a r y bank i s
unable t o pay divide nd s t o i t s p a r e n t company—as a consequence of s t a t u ­
t o r y l i m i t a t i o n s , i n t e r v e n t i o n by t h e primary s u p e r v i s o r , or noncompliance
with r e g u l a t o r y c a p i t a l requi rements—t h e bank holding company should give
s e r i o u s c o n s i d e r a t i o n t o reducing or e l i m i n a t i n g i t s dividends in o rd e r
t o conserve i t s c a p i t a l base and p ro vi de c a p i t a l a s s i s t a n c e t o t h e
s u b s i d i a r y bank".
The Federal Reserve reco gn ize s t h a t many o r g a n i z a t i o n s have
decided on t h e i r own t o reduce t h e i r divide nds w i t h i n t h e l a s t s e v e r a l y e a r s ,
and o t h e r s have done so in response t o s u p e r v is o r y encouragement.
Thus, t h i s p o li c y i s meant t o r e i n f o r c e p r u d e n t i a l c o n s i d e r a t i o n s
and t o encourage management t o c o n t i n u a l l y review divid en d p o l i c i e s in l i g h t
of an o r g a n i z a t i o n ' s f i n a n c i a l c o n d i t i o n , compliance with s u p e r v is o r y
g u i d e l i n e s on c a p i t a l adequacy, and f u t u r e growth pla ns and p r o s p e c t s .
On October 7, t h e Board announced p o l i c i e s t o i n c r e a s e t h e
frequency of o n - s i t e examination and i n s p e c t i o n of s t a t e member banks and
bank hold ing companies and s a i d i t i s c o n s i d e r i n g p o s s i b l e o t h e r a c t i o n s ,
in c l u d i n g t i g h t e n e d p r u d e n t i a l s t a n d a r d s , improved c o o r d i n a t i o n and
c o o p e r a t i o n with o t h e r f e d e r a l and s t a t e banking d e pa r tm e nt s, and
s t r e n g t h e n e d examination s t a f f s and improved examiner t r a i n i n g programs.
E a r l i e r t h i s month, t h e Board approved r e v i s i o n s t o t h e
r e p o r t i n g requirements f o r bank holding companies and implementation of
a new r e p o r t on nonbanking s u b s i d i a r i e s .

Most of t h e s e changes w i l l t a k e

e f f e c t on March 31, 1986 and a re designed t o o b t a i n new d a ta t o more f u l l y
a s s e s s o p e r a t i o n s and r i s k s , t o enhance o f f - p r e m i s e s u r v e i l l a n c e programs,
t o o b t a i n d a ta on a more f r e q u e n t b a s is and t o conform t h e account
c a t e g o r i e s and d e f i n i t i o n s , where a p p r o p r i a t e , t o th o s e of t h e c a l l r e p o r t .

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-3-

In general, th e r e v i s io n s provide f o r the submission of basic
f i n a n c i a l statements prepared in accordance with genera lly accepted
accounting p r i n c i p l e s , and fo r the c o l l e c t i o n of a lim it e d amount of
additional data which i s t o be used in the c a l c u l a t i o n of holding companies'
c a p ita l r a t i o s fo r the purpose of monitoring compliance with the Board's
c a p it a l adequacy r a t io g u i d e l i n e s .
Copies of the new reporting forms fo r bank holding companies
(Y-6 and Y-9) may be obtained from the d i s t r i c t Federal Reserve Banks.
The Board's p o licy statement on dividends i s attached.

-

Attachment

0

-

Policy Statement on the Payment
of Cash Dividends by State Member Banks
and Bank Holding Companies

The Board of Governors of the Federal Reserve System considers
adequate capital to be critical to the health of individual banking organizations
and to the safety and stability of the banking system. A major determinant of a
bank's or bank holding company’s capital adequacy is the strength of its earnings
and the extent to which its earnings are retained and added io capital or paid
out to shareholders in the form of cash dividends.
Normally,

during profitable periods,

dividends

represent

an

appropriate return of a portion of a banking organization's net earnings to its
shareholders.

However, the payment of cash dividends that are not fully

covered by earnings, in effect, represents the return of a portion of an
organization's capital at a time when circumstances may indicate instead the
need to strengthen capital and concentrate financial resources on resolving the
organization's problems.
As a m atter of prudent banking, therefore, the Board believes that a
bank or bank holding company generally shouldnot maintain its existing rate of
cash dividends on common stock unless

1) the organization's net income

available to common shareholders over the past year has been sufficient to fully
fund the dividends and 2) the prospective rate of earnings retention appears
consistent with the organization's capital needs, asset quality, and overall
financial condition.

Any banking organization whose cash dividends are

inconsistent with either of these criteria should give serious consideration to
cutting or eliminating its dividends. Such an action will help to conserve the
organization's capital base and assist it in weathering a period of adversity.
Once earnings have begun to improve, capital can be strengthened by keeping
dividends a t a level th at allows for an increase in the rate of earnings retention
until an adequate capital position has been restored.
The

Board

also

believes

it

is inappropriate

for

a

banking

organization th at is experiencing serious financial problems or that has
inadequate capital to borrow in order to pay dividends since this can result in
increased leverage at the very time the organization needs to reduce its debt or
increase its capital. Similarly, the payment of dividends based solely or largely

-2-

upon gains resulting from unusual or nonrecurring events, such as the sale of the
organization's building or the disposition of other assets, may not be prudent or
warranted, especially if the funds derived from such transactions could be
b etter employed to strengthen the organization's financial resources.
A

fundamental

principle

underlying

the

Federal

Reserve's

supervision and regulation of bank holding companies is that bank holding
companies should serve as a source of managerial and financial strength to their
subsidiary banks. The Board believes, therefore, that a bank holding company
should not maintain a level of cash dividends to its shareholders that places
undue pressure on the capital of bank subsidiaries, or that can be funded only
through additional borrowings or other arrangements that may undermine the
bank holding company's ability to serve as a source of strength.

Thus, for

example, if a major subsidiary bank is unable to pay dividends to its parent
company—as a consequence of statutory limitations, intervention by the
primary supervisor, or noncompliance with regulatory capital requirements—the
bank holding company should give serious consideration to reducing or
eliminating its dividends in order to conserve its capital base and provide
capital assistance to the subsidiary bank.
The Board's guidelines on capital adequacy define primary capital to
include perpetual preferred stock, and the Board is aware that such instruments
have become an increasingly significant element in the capital base of some
banking organizations. As part of a balanced capital structure, this instrument
can serve as a useful vehicle for supplementing common stockholders' equity,
the most critical component of an organization's capital base, and for
augmenting primary capital. However, in formulating capital plans and meeting
regulatory capital requirements, banking organizations should avoid excessive
reliance on preferred stock since this could limit an organization's financial
flexibility in the

event

it

encounters

serious

and

protracted

earnings

weaknesses.
This statem ent of principles is not meant to establish new or rigid
regulatory standards; rather, it reiterates what for most banks, and businsses in
general, constitutes prudent financial practice. Boards of directors should
continually review dividend policies in light of their organizations' financial
condition and compliance with regulatory capital requirements, and should
ensure that such policies are consistent with the principles outlined above.

-3-

Federal Reserve examiners will be guided by these principles in evaluating
dividend policies and in formulating corrective action programs for banking
organizations

that

are

experiencing

earnings

weaknesses,

asset

problems, or that are otherwise subject to unusual financial pressures.

quality


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102