February 25, 2009
Authored by: Robert Klingler
On February 24, 2009, the Federal Reserve published a Supervisory Letter regarding the ability of bank holding companies to declare dividends and to redeem or repurchase equity securities. The Supervisory Letter is generally consistent with prior guidance, although places greater emphasis on discussions with the regulators prior to dividend declarations and redemption or repurchase decisions even when not explicitly required by the regulations. Although consultation with the Federal Reserve in these situations is optional, the guidance makes clear that the failure to consult with the Federal Reserve “could result in a supervisory finding that the organization is operating in an unsafe and unsound manner.”
The Federal Reserve provides that the principles discussed in the letter are applicable to all bank holding companies, but are especially relevant for bank holding companies that are experiencing financial difficulties and/or receiving TARP Capital. To that end, the Supervisory Letter specifically addresses the Federal Reserve’s supervisory considerations for TARP Capital participants.
In addition to the general guidance provided by the Supervisory Letter and the explicit restrictions on dividends, repurchases and redemptions contained in the TARP Capital documents, the Supervisory Letter also provides guidance on how the supervisory staff will analyze TARP Capital recipients. The guidance provides that TARP recipients should “consider and communicate reasonably in advance” to supervisory staff how the bank holding company’s proposed dividends, capital redemptions, and capital repurchases are “consistent with the requirements applicable to its receipt of capital under the program and its ability to redeem, within a reasonable period of time and with Federal Reserve consent, its outstanding capital issuance under the program.” The Federal Reserve’s guidance specifically calls for the redemption of the TARP Capital “as soon as reasonably feasible and appropriate.”
The Supervisory Letter also notes that, while not expressly prohibited, bank holding company’s are “discouraged” from using the TARP Capital to pay dividends on trust preferred securities or repay debt obligations.
The Supervisory Letter provides that a board of directors should “eliminate, defer, or severely limit” dividends if:
- the bank holding company’s net income available to shareholders for the past four quarters, net of dividends paid during that period, is not sufficient to fully fund the dividends;
- the bank holding company’s rate of earnings retention is inconsistent with capital needs and overall macroeconomic outlook; or
- the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.
The Supervisory Letter further suggests that bank holding companies should inform the Federal Reserve in advance of paying a dividend that:
- exceeds the earnings for the quarter in which the dividend is being paid; or
- could result in a material adverse change to the organization’s capital structure.
The Supervisory Letter also notes that these standards equally apply to Subchapter S organizations. “For regulatory and supervisory purposes, such dividends are treated the same as those paid by other bank holding companies.”
Repurchases and Redemptions
Without modifying when regulatory approval is required, the Supervisory Letter expands the circumstances in which bank holding companies are expected to consult with the Federal Reserve before redeeming or repurchasing outstanding equity securities. Specifically:
- any bank holding company at “significant risk” of developing a financial weakness should consult with supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration;
- any bank holding company considering expansion (either acquisition or new activities) should consult with supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration; and
- any bank holding company should consult with supervisory staff before redeeming or repurchasing common stock or other regulatory capital instrument, if such redemption or repurchase will cause a net reduction in capital from the beginning of the quarter in which the redemption or repurchase occurs.