The Federal Reserve denied the request by Bank of America to increase their dividend. B of A proposed to pay common shareholders seven cents per share per quarter.
Shareholders generally like dividends. My dad went to Wharton and he often took time, when he wasn't fixing his cars, to talk about investing. He liked dividends. He felt that you could place some trust in a company that could pay a dividend. In fact, one of the first things I
learned about investing from him was that a company would have a hard time paying a dividend while not making any money.
Bank of America is losing money.
Maybe you have heard the famous axiom attributed to Mark Twain: "I am less concerned about the return on my principal as I am about the return of my principal." Bank of America is hoping to give away an additional $2.4 billion in cash (increasing the dividend from 4 cents a share per year to 28 cents a share) at a time when they lost $3.6 billion in 2010.
Here are a few reasons why shareholders should be comfortable with the Fed's decision to just say no to B of A:
1) Investors still get a dividend. The proposal was to increase the dividend by six cents per share, from one to seven.
2)Trust, but verify: We know that B of A is still holding a lot of mortgage debt from Countrywide. How can we honestly evaluate if their loan-loss set asides are adequate? Would they be adequate if the housing market dropped another 20 percent? Countrywide had a lot of concentration in California, Florida, and other states where housing prices have dropped more than national averages, too. I think it is interesting that loan-loss reserves are less than the outstanding balance of non-performing loans.
3) The Fed should know. The fact that the Fed is pushing back against B of A is unsettling.The Fed knows more than anyone, right? They must have a reason. The Fed just completed 19 stress tests. The Fed has been willing to assent to dividend increases for Wells and Chase. But they were not with B of A. Again, this is unsettling.
4) Capitalization: capital ratios are not high enough. Today's Charlotte Observer quotes Evercore Partners that B of A tier one capital ratio was between 5.5 percent and 6 percent in the last quarter. Their big bank peers are generally at 7 percent (higher is better, means greater solvency). Moynihan said he will get to 8 percent by end of 2012, how is this a step in that direction?
5) B of A is sending a bad signal about their ability to utilize capital: B of A lost $1.2 billion in the final quarter of calendar year 2010 and a total of $3.5 billion (net loss to common shareholders) for all of 2010. How is that the time to increase the dividend? Unless they feel that shareholders get a better deal by re-purposing capital away from B of A, then it makes no sense. Isn't B of A going to need that capital in order to restore its business? This is a negative signal.