Fed Urges Banks to Put Bailout Funds Into Loans, Not Dividends

Feb. 24 (Bloomberg) -- The Federal Reserve is urging Wells Fargo & Co. and dozens of banks getting bailout funds to put the money into new loans or bolster loss reserves, not to pay dividends for shareholders, two people familiar with the matter said.

That message is in the draft of a letter the Fed is preparing to send to regional bank supervisors, according to the people who saw it, speaking anonymously because it isn’t public yet. The letter represents a stepped-up effort by the Fed to more closely monitor dividends after the agency told banks in November that it was concerned they might not be using the rescue funds for new loans.

“The government’s put up some money to strengthen the banks and enable them to continue lending,” said Sherrill Shaffer, who served as the New York Fed’s chief economist in the 1980s and is now a banking professor at the University of Wyoming in Laramie. “So they expect the banks to do a little on their end to be more conservative on dividend payouts.”

JPMorgan, the second-largest U.S. bank, yesterday slashed its dividend by 87 percent to 5 cents from 38 cents. Chief Executive Officer Jamie Dimon said the decision wasn’t “directly related” to the $25 billion it received under the government’s Troubled Asset Relief Program.

“We were not asked by anyone to do this,” Dimon said on a conference call. The reduction will allow the bank to repay the government funds “as soon as is prudent,” Dimon, 52, said in a statement.

Cutting the dividend will save an additional $5 billion in common equity per year, the New York-based lender said in the statement. Even at the new reduced dividend rate, the bank will still be distributing more than $700 million a year to its shareholders.

‘Obligation’ to Shareholders

On a conference call in January, Dimon said he felt the dividend was “an obligation to our shareholders.”

The Treasury Department, Federal Reserve and other banking regulators said yesterday that the government stands ready to inject more capital into banks to “provide a cushion against larger-than-expected future losses” and “support lending to creditworthy borrowers.” The regulators tomorrow will begin a series of “stress tests” to determine if banks have enough capital to make it through the credit crisis.

When Citigroup Inc. and Bank of America Corp. sought additional aid after getting $25 billion each last October, the government agreed on the condition that they cut their dividends to a penny a share. The two banks got an additional $20 billion each from the $700 billion program.

Deborah Kilroe, a spokeswoman for the Federal Reserve in Washington, declined to comment on the pending letter to the Fed bank supervisors.

Keeping Dividends

Wells Fargo, which took $25 billion of TARP funds, has maintained its dividend. So have Pittsburgh-based PNC Financial Services Group, which took $7.6 billion; Minneapolis, Minnesota- based U.S. Bancorp, which received $6.6 billion; and McLean, Virginia-based Capital One Financial, which got $3.6 billion.

Goldman Sachs Group Inc., the New York-based securities firm that converted to a bank holding company last year and got $10 billion of TARP funds, is still paying a quarterly dividend equivalent to 35 cents a share. New York-based Morgan Stanley, which also got $10 billion, pays 27 cents a share.

Spokesmen for Wells Fargo, Goldman Sachs, Morgan Stanley and PNC declined to comment. “These funds are being used in a manner consistent with promoting economic growth,” Capital One spokeswoman Julie Rakes said.

U.S. Bancorp spokesman Steve Dale declined to comment. CEO Richard Davis said on a Jan. 21 conference call that while he understands that the dividend represents “a value to our investors,” there has “never been anything rubber-stamped about it.”

‘Money Is Fungible’

At a Feb. 11 hearing in Washington before the House Financial Services Committee, Morgan Stanley Chief Executive Officer John Mack testified that his firm didn’t use TARP money “to pay compensation, nor did we use it to pay dividends or lobbying costs.”

The comment drew a reprimand from Representative Brad Sherman, a Democrat from California, telling Mack that “money is fungible” and that it was a “rather silly claim” to say that TARP capital was separate from money going to pay dividends.

“Don’t insult our intelligence,” Sherman said at the hearing. “You had extra money, and instead of loaning it to the economy, instead of repaying it to the taxpayers, which is what you should have done, you sent it out as dividends to your shareholders.”

In January, when Wells Fargo posted a fourth-quarter net loss of $2.55 billion, the bank said it would keep its quarterly dividend at 34 cents a share. Based on the San Francisco-based bank’s 3.59 billion shares outstanding as of Dec. 31, that’s about $4.9 billion a year of dividends.

Eroding Profits

Meredith Whitney, the former Oppenheimer & Co. analyst who correctly predicted in late 2007 that Citigroup would have to cut its dividend, said last week she thought JPMorgan, Wells Fargo, Goldman Sachs, Morgan Stanley and Capital One would have to cut their dividends as the credit crisis erodes profits.

The Fed’s new guidance may provide cover to bank CEOs who know they need to cut their dividends to preserve capital, and have resisted doing so for fear of upsetting shareholders or conveying a sign of weakness to depositors, Shaffer said.

“Now they can say, ‘Don’t blame me, blame the regulators,’” Shaffer said. “‘We had complete financial ability to maintain our dividend, but the regulators were hard on us, and they’re being hard on the whole banking system.’”

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net.

To contact the editor responsible for this story: Alec D.B. McCabe at amccabe@bloomberg.net