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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 (OVER) -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 . (OVER) -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