The FDIC Has A Problem With Bank Of America’s Proposed Dividend Increase

Speaking at Bank of America’s first investor conference since 2007, Chief Executive Brian Moynihan told shareholders that he was focused on increasing shareholder returns through share buybacks, special cash dividends and increased regular dividends.

Mr. Moynihan also cheered investors on by predicting that Bank of America could earn, under normal business conditions, up to $40 billion per year pretax.  All good news for investors who pushed up the price of the Bank’s stock by 4.7% to $14.69 per share.

Bank of America (BAC) shareholders have been treated to a quarterly dividend of a mere penny a share since January 2009.  Dividends had reached an all time high quarterly payout of $.64 from July 2007 through July 2008 but were drastically reduced as the mortgage meltdown caused massive losses at Bank of America.

Government assistance from the TARP program amounting to $45 billion was necessary to prevent the collapse of Bank of America in early 2009.  In addition to the TARP funds, Bank of America also took advantage of the FDIC’s Temporary Liquidity Guarantee Program (TLGP) under which it issued $44.5 billion of senior unsecured debt which was fully guaranteed by the FDIC.

Massive government assistance, virtually zero funding costs and a tepid economic recovery have since allowed Bank of America to partially recover.  The Bank paid back the entire $45 billion of TARP funds in December 2009.  The $44.5 billion borrowed under the FDIC’s Debt Guarantee Program has not been repaid, leaving the FDIC on the hook for any future default.

While many other large banks such as Wells Fargo and US Bank have reported surging profits, Bank of America had a net loss of $3.6 billion for the year ending December 31, 2010, and has been beset by a host of financial problems which remain unresolved.

The current annual dividend of 4 cents per share amounts to $405 million per year.  A return to the previous dividend rate of $.64 per quarter would mean an annual payout to shareholders of almost $26 billion on BAC’s 10.12 billion outstanding shares.

The Federal Reserve is currently considering if banks should be allowed to resume paying dividends.  Mr. Moynihan’s rosy scenario for Bank of America’s future may be a highly public attempt to influence the forthcoming regulatory decision on allowing dividend payments.

The timing and remarks at the Bank of America investor conference also closely follow testimony given by Jason Cave, FDIC Deputy Director for Complex Financial Institutions, to the Congressional Oversight Panel on March 4.  Mr. Cave stated that the FDIC opposes the approval of dividend payments and capital repurchases.

Central to FDIC concerns is the amount of unpaid FDIC guaranteed debt which Mr. Cave said “warrants continued close scrutiny”.  At the peak of the program, the FDIC had issued guarantees on $350 billion of bank debt.  As of December 31, 2010, the FDIC still had outstanding debt guarantees of $267 billion with maturities running out to 2012.

The FDIC is closely monitoring their exposure by requiring that issuers have “concrete and practical plans in place to fully repay their TLGP debt under normal and adverse scenarios”.  The FDIC is also evaluating the optimistic liquidity assumptions of the largest TLGP borrowers to ensure that funding is available to timely redeem TLGP guaranteed debt.  In addition, the FDIC is encouraging banks to lock in long term funding now instead of waiting until the TLGP debt matures and credit conditions may be less favorable.

FDIC Deputy Director Cave said the FDIC is working with the Federal Reserve on a comprehensive review of dividend and capital repurchase plans since such payments were a “large drain on cash reserves prior to the crisis, leaving institutions more vulnerable to the disruptions that followed”.  Director Cave said it would be “short-sighted and inappropriate” to ignore TLGP funding requirements simply because the debt is not due for another 12 to 18 months.  The FDIC’s view is that dividend payments could have an adverse impact on the ability of banks to repay TLGP guaranteed debt with private borrowing, leaving the FDIC with potentially massive loss exposure.

Director Cave made it clear that the FDIC was very active in the discussions regarding dividend and capital buybacks and stated that “We believe the FRB (Federal Reserve Bank) shares our concerns and we look forward to continuing to work with them on the dividend and TLGP repayment reviews”.

Considering the slow economic recovery and the risks to the FDIC under the TLGP guarantees, regulators should take a very conservative approach on giving the go ahead for dividend payments by the banks.  Despite the super optimistic outlook by Bank of America’s Chief Executive, shareholders counting on a dividend increase are likely to be disappointed.