Creating the Correct Dividend Policy


dividend-7-17-19.png“I believe non-dividend stocks aren’t much more than baseball cards. They are worth what you can convince someone to pay for it.” – Mark Cuban, investor and owner of the NBA’s Dallas Mavericks

Directors can use dividends to convey confidence and attract yield-hungry investors, but they must strike a balance between payouts and future growth.

Dividends are an important part of the capital management strategy at many banks, and the operating environment has made yield more important to analysts and investors. A bank’s dividend policy is a highly visible signal of management’s confidence to deliver consistent results. The board of directors is responsible for determining a bank’s cash dividend; it is paramount they strike the right payout.

After carefully considering regulatory capital requirements, a board still has a fair amount of discretion when establishing the dividend policy while retaining sufficient funds for growth. Boards often weigh dividends against share repurchases to manage capital. However, trading multiples and capital levels heavily influence stock repurchases, which tend to be more discretionary than regular dividend payments. A lower tax rate on dividends and ordinary income is another factor that favors dividends over share repurchases.

Dividends can be a good measure of corporate governance. A dividend payout policy means that investors can worry less about unchecked growth or inefficient investments that do not maximize shareholder value.

Optimal Dividend Policy
The appropriate capital management policy can help a bank achieve an optimal trading multiple. The optimal dividend policy depends on a company’s earnings growth, capital requirements and ability to communicate its strategy to the investment community. Although cash dividends have been historically respected by bank investors, the prolonged low interest rate environment and the perception that banks are increasingly utility-like has elevated the importance of dividend payouts.

There is, however, an opportunity cost of using cash to pay out dividends rather than fuel growth initiatives. And an increased dividend can indicate that management expects higher future cash flows and possibly higher future valuations.

The Federal Reserve’s monetary policy encourages yield-hungry investors to favor stocks over fixed-income instruments. Given the current economic and interest rate environment, equity investors can achieve the safety of bonds through a combination of cash dividends and any upside from capital appreciation inherent in stocks. Dividend popularity has increased, due to respectable corporate cash flows, more favorable tax rates, and broad consumer confidence in the economy and stock market. Currently, the S&P 500 dividend yield is around 1.86 percent, compared to a 2.4 percent yield on 10-year Treasury notes.

In response to these considerations, management should determine the retention ratio, which lies in the earnings power above the dividend payment. Effectively measuring market, liquidity and credit risk—often done through stress testing—is vital to determining the margin of protection a bank needs to ensure the consistency of dividend payments. The DuPont formula, where return on equity equals return on assets times the equity multiplier, should underpin the financial perspective.

Industry-wide challenges like continued pressure on net interest margins and a diminishing ability to trim reserves will stretch the safety margin in the current environment. Banks with slower earnings growth need to carefully determine their dividend payout ratios. Increasing or stable dividends are generally positive signals to the market regarding the institution’s financial condition and prospects, while a dividend cut could paint a negative picture.

Changing Investor Views
The attitudes of analysts and the investment community regarding dividends have come full circle. This was not always the case, as investors preferred that banks retain capital for growth or to fund stock repurchases.

Retail investors, including executives and members of the board, are attracted to community bank stocks because of the sector’s predictable dividend payments. Directors would be well advised to focus on their bank’s dividend policy and the efficient use of capital as part of their fiduciary duties to shareholders.

How to Design a Winning Capital Management Plan


capital-4-22-19.pngThe significant downturn in bank stock prices witnessed during the fourth quarter of 2018 prompted a number of boards and managements to authorize share repurchase plans, to increase the amounts authorized under existing plans and to revive activity under existing plans. And in several instances, repurchases have been accomplished through accelerated plans.

Beyond the generally bullish sentiment behind these actions, the activity shines a light on the value of a proactive capital management strategy to a board and management.

The importance of a strong capital management plan can’t be overstated and shouldn’t be confused with a capital management policy. A capital management policy is required by regulators, while a capital management plan is strategic. Effective capital management is, in large part, an exercise in identifying and understanding future risks today. Capital and strategy are tightly linked — a bank’s strategic plan is highly dependent on its capital levels and its ability to generate and manage it.

There are a couple of guidelines that executives should bear in mind as they develop their capital management plans. First, the plan needs to be realistic and achievable. The windows for accessing capital are highly cyclical. There’s limited value in building a plan around an outcome that is unrealistic. Second, if there is credible information from trusted sources indicating that capital is available – go get it! Certain banks, by virtue of their outstanding and sustained performance, may be able to manage the just-in-time model of capital, but that’s a perilous strategy for most.

Managements have a number of levers available to manage capital. The key as to when and which lever to pull are a function of the strategic plan. A strong plan is predicated on staying disciplined but it also needs to retain enough nimbleness to address the unforeseen curveballs that are inevitable.

Share Repurchases
Share repurchases are an effective way to return excess capital to shareholders. They are a more tax-efficient way to return capital when compared to cash dividends. Moreover, a repurchase will generally lift the value of a stock through the reduction in shares outstanding, which should increase earnings per share and the stock price itself. Share repurchases are generally the favored mechanism of institutional owners and can make tremendous sense for broadly held and liquid stocks.

Cash Dividends
Returning capital to shareholders in the form of cash dividends is generally viewed very positively in the banking industry. Banks historically have been known as cash-dividend paying entities, and the ability and willingness to pay them is often perceived as a mark of a healthy and stable company. A company’s decision regarding whether to increase a cash dividend or to repurchase shares can be driven by the composition of the shareholder base. Cash dividends are generally valued more by individual shareholders than institutional shareholders.

Business Line Investment
Community banking at its core is a spread dependent business. The ability to diversify the revenue stream through the development or acquisition of a fee generating business can be an effective and worthwhile use of capital. Common areas of investment include mortgage banking, wealth management, investment products and services and insurance. Funding the lift out of lending teams can also be a legitimate use of capital. A recent development for some is investment in technology as an offensive play rather than a defensive measure.

Capital Markets Access
Effective capital management plans also consider the ability to access the capital markets. In the community banking space, accessing capital is not always a foregone conclusion. Over the past couple of years, the most common forms of capital available have been common equity and subordinated debt. For banks of a certain size and market cap, it’s a prudent capital management strategy to file a shelf registration, also known as form S-3, which provides companies with flexibility as to how and when they access the capital markets. The optionality provided by having a shelf registration far outweighs the concern that the shelf itself suggests a shareholder dilutive activity is on the horizon.

It’s important to note that these capital management activities can be utilized individually or in combination. An acquisition may necessitate the need to access the capital markets. Or given the relative inexpensiveness of sub debt, raising some for the purpose of a share repurchase could make sense. A strong capital management plan can allow a management team to be ready both offensively and defensively to drive their businesses forward in optimal fashion.

Information contained herein is from sources we consider reliable, but is not guaranteed, and we are not soliciting any action based upon it. Any opinions expressed are those of the author, based on interpretation of data available at the time of original publication of this article. These opinions are subject to change at any time without notice.

Four Ways to Effectively Deploy Excess Capital


capital-7-23-18 (1).pngFavorable economic conditions for banks, which include a healthy business sector, a rising interest rate environment, and the impact of tax and regulatory reforms, have resulted in strong earnings for many community banks. While this confluence of positive market developments has led many growing banks to tap public and private markets for additional capital to fund growth opportunities, many other institutions are facing an opposing challenge.

These institutions, many of which are located in non-metropolitan markets, are experiencing record earnings yet do not have existing loan demand to effectively deploy the capital into higher yielding assets. As a result, these institutions must evaluate how best to deploy excess capital in the absence of organic growth opportunities in existing markets to avoid the impact on shareholder returns of reinvestment into the securities portfolio during a period that continues to be characterized by historically low interest rates.

Dividends. Returning excess capital to shareholders through enhanced dividend payouts increases the current income stream provided to shareholders and is often a well-received option. However, in evaluating the appropriate level of dividends, including whether to commence paying or increase dividends, banks should be aware of two potential issues. First, an increase in dividends is often difficult to reverse, as shareholders generally begin to plan for the income stream associated with the enhanced dividend payout. Second, the payment of dividends does not provide liquidity to those shareholders looking for an exit. Accordingly, dividends, while representing an efficient option for deploying excess capital, presents other considerations that should be evaluated in the context of a bank’s strategic planning.

Tender Offers and Other Stock Repurchases. Stock repurchases, whether through a tender offer, stock repurchase plan or other discretionary stock repurchase, enhance liquidity of investment for selling shareholders, while creating value for non-selling shareholders by increasing their stake in the bank. Following a stock repurchase, bank earnings are spread over a smaller shareholder base, which increases earnings per share and the value of each share. Stock purchases can be a highly effective use of excess capital, particularly where the bank believes its stock is undervalued. Because repurchases can be conducted through a number of vehicles, a bank may balance its desire to effectively deploy a targeted amount of excess capital against its need to maintain operational flexibility.

De Novo Expansion into Vibrant Markets. Banks can also reinvest excess capital through organic expansion into new markets through de novo branching and the acquisition of key deposit or loan officers. For example, a rural bank with a high concentration of stable, inexpensive deposits but weak loan demand could expand into a larger market where loan demand is strong but deposit pricing is elevated. By doing so, the bank can leverage excess capital and inexpensive deposits through quality loan growth and, optimize its net interest margin and earnings potential. With advances in technology, overhead costs associated with de novo entry into a new market have substantially decreased, although competition for deposit and loan officers is intense. Startup costs may be further diminished through a loan production office, rather than a branch in a new market.

Mergers and Acquisitions. Banks can deploy excess capital to jumpstart growth through merger and acquisition opportunities. In general, size and scale boost profitability metrics and enhance earnings growth, and mergers and acquisitions can be an efficient mechanism to generate size and scale. Any successful acquisition must be complementary from a strategic standpoint, as well as from a culture perspective. For example, a bank’s acquisition strategy could involve joining forces with, or eliminating, a competitor with a complementary business and corporate culture. Alternatively, it could be driven by corporate objectives to enhance earnings by expanding into a larger market with stronger demand for high-quality loans. On the other hand, an institution based in a metropolitan market may be inclined to target a lower growth market with a high concentration of lower cost, core deposits. In either case, the acquisitions are complementary to the institutions.

All banks with excess capital have strategic decisions to make to maximize shareholder value. In many cases, these decisions result in returning capital to shareholders, while others seek to leverage excess capital in support of future growth. The strategy for deploying excess capital should be a material component of a bank’s strategic planning process. There is no universal, or right, answer for all banks. Each bank must consider its options against its risk tolerance, long-term strategic goals and objectives, shorter term capital needs, management and board capacity.

Creating Liquidity: Alternatives To Selling The Bank



Executives and boards of private banks have to think outside the box if they want to create a path to liquidity for shareholders that doesn’t require selling the bank. In this video, Eric Corrigan of Commerce Street Capital outlines three liquidity alternatives to consider, and shares why a proactive approach can help a bank control its own destiny.

  • Challenges in Creating Liquidity
  • Three Liquidity Alternatives
  • Benefits and Drawbacks to Each Solution
  • Questions Boards Should Be Asking