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FEDERAL RESERVE BANK OF NEW YORK [ Circular N o. 9 9 5 5 N ovem ber 21, 1985 1 J SUPERVISION OF STATE M EM BER BANKS AND BANK H O LD IN G COM PANIES — Paym ent of Cash Dividends by Banks in Financial Difficulties — New R eporting R equirem ents for Bank Holding Com panies To A ll State M em b er B a n ks and B a n k H olding C om panies in the S eco n d F ederal R eserve D istrict: Following is the text of a statement issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board has issued a policy statement on the payment of cash dividends by State member banks and bank holding companies that are experiencing financial difficulties. The policy statement, which is part of a program to strengthen supervision of banking operations, addresses the fol lowing practices of supervisory concern by institutions that are experiencing earnings weaknesses or other serious prob lems, or that have inadequate capital: — the payment of dividends not covered by earnings. — the payment of dividends from borrowed funds, and — the payment of dividends from unusual or nonrecurring gains, such as the sale of property or other assets. It is the Federal Reserve’s view that an organization experiencing earnings weaknesses or other financial pressures should not maintain a level of cash dividends that exceeds its net income, that is inconsistent with the organization’s capi tal position, or that can only be funded in ways that may weaken the organization’s financial health. In some instances, it may be appropriate to eliminate cash dividends altogether. The policy statement reads in part: “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 share holders 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 conse quence of statutory limitations, intervention by the primary supervisor, or noncompliance with regulatory capital re quirements — 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 Federal Reserve recognizes that many organizations have decided on their own to reduce their dividends within the last several years, and others have done so in response to supervisory encouragement. Thus, this policy is meant to reinforce prudential considerations and to encourage management to continually review dividend policies in light of an organization’s financial condition, compliance with supervisory guidelines on capital ade quacy, and future growth plans and prospects. On October 7, the Board announced policies to increase the frequency of on-site examination and inspection of State member banks and bank holding companies and said it is considering other possible actions, including tightened pruden tial standards, improved coordination and cooperation with other Federal and State banking departments, and strength ened examination staffs and improved examiner training programs. Earlier this month, the Board approved revisions to the reporting requirements for bank holding companies and im plementation of a new report on nonbanking subsidiaries. Most of these changes will take effect on March 31, 1986 and are designed to obtain new data to more fully assess operations and risks, to enhance off-premise surveillance programs, to obtain data on a more frequent basis and to conform the account categories and definitions, where appropriate, to those of the call report. In general, the revisions provide for the submission of basic financial statements prepared in accordance with gener ally accepted accounting principles, and for the collection of a limited amount of additional data which is to be used in the calculation of holding companies’ capital ratios for the purpose of monitoring compliance with the Board’s capital ade quacy ratio guidelines. Printed below is the text of the Board’s policy statement. Copies of the new reporting forms (Y-6 and Y-9) will be mailed to all bank holding companies in this District as soon as they are available. Additional copies of the forms will be furnished upon request directed to our Bank Analysis Department. Questions regarding the Board’s policy statement may be directed to Donald E. Schmid, Manager, Bank Analysis Department (Tel. No. 212-791-6611). E. Gerald Corrigan, P resid en t. 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 de terminant of a bank’s or bank holding company’s capi tal adequacy is the strength of its earnings and the ex tent to which its earnings are retained and added to cap ital or paid out to shareholders in the form of cash divi dends. 2 Normally, during profitable periods, dividends represent an appropriate return of a portion of a bank ing organization’s net earnings to its shareholders. However, the payment of cash dividends that are not fully covered by earnings, in effect, represents the re turn 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 matter of prudent banking, therefore, the Board believes that a bank or bank holding company generally should not maintain its existing rate of cash dividends on common stock unless (1) the organiza tion’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends a n d (2) the prospective rate of earnings re tention appears consistent with the organization’s capi tal needs, asset quality, and overall financial condi tion. Any banking organization whose cash dividends are inconsistent with either of these criteria should give serious consideration to cutting or eliminating its divi dends. Such an action will help to conserve the organi zation’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 at a level that allows for an increase in the rate of earnings retention until an adequate capital position has been re stored. The Board also believes it is inappropriate for a banking organization that is experiencing serious fi nancial 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. Simi larly, the payment of dividends based solely or largely 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 better 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, there fore, 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 3 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 regula tory 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 de fine 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 stock holders’ equity, the most critical component of an or ganization’s capital base, and for augmenting primary capital. However, in formulating capital plans and meeting regulatory capital requirements, banking or ganizations should avoid excessive reliance on pre ferred stock since this could limit an organization’s fin ancial flexibility in the event it encounters serious and protracted earnings weaknesses. This statement of principles is not meant to estab lish new or rigid regulatory standards; rather, it reiter ates what for most banks, and businesses in general, constitutes prudent financial practice. Boards of direct ors should continually review dividend policies in light of their organizations’ financial condition and compli ance with regulatory capital requirements, and should ensure that such policies are consistent with the princi ples outlined above. Federal Reserve examiners will be guided by these principles in evaluating dividend poli cies and in formulating corrective action programs for banking organizations that are experiencing earnings weaknesses or asset quality problems, or that are other wise subject to unusual financial pressures.
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