They say you can never be too rich or too thin. But too safe? Apparently that can be a problem. In an earnings call with analysts in January, JPMorgan Chase (JPM) CEO Jamie Dimon said that the way things are going now, many banks will be "overcapitalized" by mid- to late-2010. As banks have increased profits, or sold shares and hoarded cash on regulators' orders, their safety margins have substantially exceeded regulatory minimums. Now they are coming under pressure from various fronts to surrender some of that cushion—and shareholders, pushing for fatter dividends, may have the best chance of getting their hands on the money.
Overcapitalization may sound like a good problem to have, considering that only a year or so ago the federal government was racing to save the U.S. financial system from outright collapse. Surprisingly, though, having too much money can be almost as bothersome as not having enough. Pressures on Dimon and other bank CEOs are mounting from multiple directions: from shareholders who want bigger payouts; small businesses that say the banks should make more loans to revive the economy; employees who want bigger bonuses; and the Obama Administration, which wants to tax big banks to cover the government's $117 billion in projected losses from the bailout.
Of all the competing claims, shareholders' demands for higher dividends may be the most likely to succeed. JPMorgan Chase, regarded as the best managed of the large banks, will probably be the first to hike payments. In the call discussing the bank's $3.3 billion fourth-quarter profit, JPMorgan Chase reiterated plans to raise the annual dividend, now 20¢ a share, to 75¢ or $1 in the second half of this year, assuming the economy continues to recover and loan losses are in line with expectations. Says Matthew D. McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati: "If you can be the first bank to increase the dividend, that's going to make a statement to the investing public."
Shareholders can make a strong case for the money. The average dividend yield of big banks—that is, the dividend divided by the stock price—is at its lowest since 1997. Federal regulators understand that banks need to reward shareholders so they'll be willing to buy future issues and build up the companies' capital base. It's a fine line on how tough to get on limiting dividend hikes, says one federal regulator who asked not to be named, adding it's going to be challenging to get the balance right.
The financial institutions don't plan on emptying out their treasuries to pay for higher dividends. Dimon, for one, is intent on keeping JPMorgan Chase well-capitalized. He says regulatory minimums for capital are going to be raised in the next few years. "No one wants to be caught short in capital, particularly if someone is going to be punitive about it," Dimon told analysts. Higher payouts will come at a cost. Each dollar paid out in dividends is a dollar not available for fresh lending or covering surprise losses on loans.
An increase by JPMorgan Chase will pressure other banks to raise their dividends, even though their finances may not be as sturdy. While U.S. Bancorp (USB) and BB&T (BBT) may also hike their payouts this year, according to analyst Jason M. Goldberg of Barclays Capital (CS), Citigroup (C) and Bank of America (AC) probably won't be able to do so until at least 2011. (Spokesmen for Bank of America, Citigroup, and Wells Fargo (WFC) declined to comment on their plans.)
An abundance of capital by itself is no guarantee of health. By one measure, Citi's capital amounts to 11.7% of assets, more than JPMorgan Chase's 11.1% and well above the 6% regulatory minimum. But no one would argue that Citi is in good shape. It reported a $7.6 billion fourth-quarter loss this month, and CEO Vikram Pandit faces continued high default rates on his loan portfolio. (A spokesman for the Office of the Comptroller of the Currency says its examiners don't rely solely on banks' capital ratios to determine their soundness.) Before JPMorgan or any other bank boosts its dividend, it will have to get clearance from its overseers. Federal Reserve guidelines say regulators must consider "current and prospective earnings" as well as "prevailing market and economic conditions" when evaluating the request.
Some economists argue that even the strongest institutions should be conserving their cash, because a big decline in asset values could still leave them insolvent and in need of a taxpayer bailout. "We don't want big banks, even responsible big banks, to gamble with the taxpayers' chips," says Boston University economist Laurence J. Kotlikoff. One reason for concern: Banks could still get smacked by losses on their vast portfolios of real estate loans, says Edward Casas, head of Navigant Capital Advisors, a corporate finance adviser in Skokie, Ill. One sign that the companies haven't fully recognized their losses, says Casas, is that they're reluctant to sell assets at the going market price. He says midsize and small transactions "are still basically frozen" because banks won't cut their asking prices enough.
The cash cushion highlights another dilemma: Should banks lend more money or should they be tougher about granting loans to limit the risk of defaults? Loans on banks' books fell from $7.3 trillion in October 2008 to just under $6.7 trillion in early January 2010. Politicians have demanded that institutions step up lending to help lift the economy. Presumably banks would like to comply, since that's how they make their money. The $1 trillion they have stashed at the Federal Reserve earns just 0.25% a year.
The main reason for the decline in lending is that the recession has turned some would-be borrowers into bad risks and suppressed demand for credit from others. The National Federation of Independent Business says that in December only 8% of its small-business members reported they had credit needs that weren't satisfied, vs. about 5% who say so when credit is flush.
But some banks may have dialed back too far. In Denver entrepreneurs Frank Alfonso and Bill Cossoff had to get their local congressman's help to land a loan to open a third Big Papa's BBQ restaurant. In Los Angeles, Lourdes Sobrino says she was turned down by 15 or more banks for a $500,000 loan to relocate her Mexican-style Lulu's Dessert business, which employs 45 people. Facing a Jan. 22 deadline to vacate her current premises, she was seeking outside investors instead. Her problem: The 28-year-old company lost money in 2009. "I've had loans all my business life," says Sobrino. "I paid all of them successfully. The banks say, 'We're very conservative.' …Honestly, they don't care."
The other people grabbing for a piece of the banks' stash are the bankers themselves, who want higher salaries and bonuses. At JPMorgan, average pay at the investment bank rose 37% last year. But industry earnings may well fall in 2010, and if they do, pay could fall in tandem, says Alan Johnson, managing director of Johnson Associates, a New York-based compensation consultant.
Meanwhile, prospects for the Obama tax on banks are uncertain. The levy faces a possible constitutional challenge and accusations of unfairness. Warren Buffett opposes a tax. "This is not conducive to an investor-friendly environment," says Peter Sorrentino, who helps manage $13.8 billion at Huntington Asset Advisors in Cincinnati. A senior Obama Administration official says the White House is hoping the banks will take the money largely out of their bonus pools, but that would not be required.
In short, lots of people want to get their hands on the money of those "overcapitalized" banks. But at the moment, it looks like shareholders will be getting first dibs.
Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkThe Big Number
Everyone from Wall Street to Washington is fixated on the final tally for bank bonuses, says a Jan. 10 article in The New York Times. Some executives and top performers may get eight-figure sums this year. While many banks are handing out stock awards instead of just cash, the move may not be enough to placate the public. "The debate has shifted in the last nine months or so from just 'less cash, more stock' to 'what's the overall number?'" said Robert P. Kelly, chief executive of the Bank of New York Mellon.
To read the story, go to http://bx.businessweek.com/financial-services-industry/reference/.