Some banks not paying TARP dividends

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A friend sent me the following article from USA Today:

The U.S. taxpayers’ investments in smaller banks are increasingly at risk.

In a sign that more banks are under great pressure from the recession, 34 financial institutions did not pay their quarterly dividends in August to the Treasury on funds obtained under the Troubled Asset Relief Fund (TARP). The number almost doubled from 19 in May when payments were last made, and also raised questions about Treasury’s judgment in approving these banks as "healthy," a necessary step for them to get TARP funding.

"The banks are not paying their dividends because they are worried about preserving capital," says Eric Fitzwater, associate director of research at SNL Financial.

The Treasury Department says it cannot force an institution to pay dividends. "For some banks, it may be prudent to exercise their right not to pay dividends in a particular month, and we respect their right to do so," says Meg Reilly, a Treasury spokeswoman. "To draw any broader conclusions about the state of the banking sector from one month is highly premature and speculative."

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Dividend payment is not enforceable by law. The government has to accept a ‘cut’ in its dividend payment just like private investors do.  What is interesting is I wrote about this problem of capital constrained banks’ inability to pay TARP dividends back in January:

Honestly, I do not know how to sidestep this issue because the government should be compensated for its efforts as a normal investor would.  Zero-coupon bonds would generate the same accounting effect, even though no money was changing hands.  Payment-in-kind (PIK) preferred shares would be seen as inadequate.  Common stock would be dilutive to existing shareholders and is one reason not to hold stock in these companies.  Converting dividend-paying preferred shares into common stock may be the best route forward.

If anyone has a solution, feel free to chime in.

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And, of course we know that the government has indeed converted their pref shares at Citi into common. Is this what we are likely to see at these smaller institutions as well?  I see this as further evidence that many banks are still very-much capital constrained.

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