The Office of the Comptroller of the Currency has warned national banks to use caution in deciding whether to increase dividend payouts to shareholders because of a significant deterioration of the quality of loans on the books of many institutions.
Acting Comptroller of the Currency H. Joe Selby, in a memorandum to banks released publicly yesterday, said that even though bank profits have been rising it might not be prudent for banks to increase their dividends.
Banks, like most companies, can do two things with their after-tax profits. They can pay them out as dividends or they can retain them. Retained earnings become part of a bank's capital, which is the ultimate bulwark against loan losses.
Instead of raising payouts to shareholders, Selby's memo said, some banks should add the increased profits to retained earnings as a cushion against the higher risk of loss from their loan portfolios.
"Cash dividends represent a distribution of net income. They should bear a direct correlation to the level of the bank's current and expected earnings stream, the bank's need to maintain an adequate capital base and the marketplace's perception of the bank -- not the financial expectations of bank shareholders," Selby said in the memorandum, dated Oct. 30.
"Paying dividends that deplete a bank's capital base to an inadequate level constitutes an unsafe and unsound banking practice," Selby said.
He said an analysis prepared by the comptroller's office -- which regulates the 4,700 banks with federal charters -- indicates that "retained earnings of many banks have not kept pace with the increased level of risk and volatility banks are experiencing under the current economic environment."
James McDermott, chief banking analyst of the securities firm Keefe, Bruyette & Woods, said the comptroller's memorandum reflects tighter supervision over bank management that has been evident since the de facto failure of Continental Illinois National Bank in the spring of 1984.
Regulators have become very active in dealing with capital, loan exposure and foreign loans, McDermott said.
In his memo to the banks, Selby cited loans in agriculture, oil and gas, and commercial real estate as having a "significant adverse impact on the level of classified problem assets and the resulting earnings of many banks." He said that loans to troubled Third World countries are a problem at many bigger banks.
He said that bank managements and boards of directors should develop capital plans complete with "financial projections, budgets and dividend guidelines" and review at least once a year. He warned that bank examiners would scrutinize the plans.