Bank Investors Worry about Dividend Payments

Bank investors

A certain sector of bank stock investors, those who invest to collect dividends, don’t seem bothered no matter how much money they lose on stocks, but hands-off dividends.

There seems to be no limit to how far many investors are willing to go in order to keep collecting their quarterly dividend payments. They will hold fast in the midst of any crisis, and we really know how true this is now, in the midst of the current circumstances surrounding these stocks.

When we see these stocks lose over half their value, and not only do investors not seem to care, they don’t even seem to notice, we already know with certainty that there is something seriously wrong with their thinking. A lot of these investors might even be suckers enough to buy the Brooklyn Bridge, if there were a good-sized dividend payment that came along with it.

Bank stocks historically pay out a single percentage of the value of their stocks in quarterly dividend payments, but somehow this 1% becomes bigger and more important than losing more than 50% of your investment to collect it, if you are even going to be collecting it this time. We’re not even sure whether those foolish enough to think that they could buy the Brooklyn Bridge would fall for such a ruse, because the dividend ruse requires that you not only be a sucker, you also need to be very bad at math, confoundingly bad actually, where the number 1 is seen as a bigger one than the number 50.

On top of this, even those who may not be aware that the Brooklyn Bridge is not held privately and cannot be bought from an individual understand how much trouble our economy is in right now. We have poured trillions of dollars into the financial system so far, and this Is not because banks are so rife with capital that they don’t know what else to do with it other than to just hand a good part of it out to investors.

Banks may seem to be holding up pretty well so far, and they have been given plenty of liquidity by the Fed, an abundance of it in fact, and that part of the equation has been managed well so far, as it must be. Rock-bottom interest rates are troublesome enough for banks though, which cuts into their profits, and this is especially a problem in today’s strange times, where we have the low rates but we don’t have the expansion to offset it, and quite the contrary.

We might think that the huge small business loan package will help banks as well, but Congress has set the interest rate with these loans at a measly half a percent a year, far below what banks require to make a profit, and these loans cost banks more than they get back.

This is a small deal though compared to the bill yet to come, and it will be a big one, especially if this massive economic contraction persists for very much longer. As we seek to push back the date to return to normalcy further and further out, the economic losses that will be felt continue to mount, and banks are the backstop here, where the losses will ultimately be felt.

We’re not even sure how bad this will end up being because we don’t even have an end date or any real history to compare with, but it’s pretty clear that we’re looking to write off the month of April as well, and perhaps beyond that. Each default that occurs results in lenders being left to hold the bag, and we already know how bad that can be when we look at what all those defaults did to the banking industry during the last crisis.

This crisis is much broader though, with everyone being affected, from the biggest of corporations down to the people on the street. We had to step in and bail out the banks last time, but this time, just about everyone needs a bailout, and we can only do so much.

Should banks require bailouts again, who will ultimately foot the bill for the economic losses that we occur from tying ourselves up for this long, the very idea of allowing banks to take some of this money and hand it out to shareholders like it was a party is something that we should find appalling, but that’s just only one reason not to want to permit this.

This would require completely irresponsible management, much like the government stocking your bank’s vault, you handing out some of the money to people walking by on the street, and then needing more to keep the vault full enough to handle business needs.

In a time where the liquidity of banks will come under such intense pressure as they bear massive losses from all the coming defaults, this is no time to allow shareholders to help themselves to the working capital of these banks.

Sure, these shareholders do own the company and can normally make whatever rules they want within the regulatory framework that we have set out, but these are not normal times, and when you come begging to the government to bail you out, as they will, you aren’t entitled to just take this money and put it in your own pocket just because you can.

Not only do these handouts need to come with conditions, we don’t even need the presence of handouts to require regulators to set these conditions, as seeking to preserve the health of the financial system is plenty enough reason, and prohibiting bank dividends would serve to improve the health of these crucial institutions at the best of times.

This is not impinging upon the profitability of these investments though, as prohibiting dividends with bank stocks or with any stocks serves to make these investments more profitable as it turns out, where everyone wins if we nix these payments, and everyone loses to some degree if we don’t, since the public itself bears the burden and cost of putting out any fires that come, and we are therefore entitled to have them practice better fire safety.

We Hate to See Pockets Being Lined During Crises, and This Needs to Include Shareholders

Paying dividends in a financial crisis like this is not unlike fat cat bankers lining their pockets with millions while Rome burns, like we saw in 2008, when their banks were on the precipice of doom and they continued to siphon off working capital to keep it for themselves rather than to at least try to shore up a ship that was sinking fast, or already under water.

People had no reservations about calling for these practices to stop once the big wave hit and they were all in the lifeboats. Somehow, dividends aren’t seen that way at all, although they really need to because this is syphoning off needed capital as sure as big bonuses is, at a time where it is highly inappropriate and puts our banking system at greater risk, risk that can be better managed by plugging these holes.

While we may think of dividends as a form of profit sharing with shareholders, and this is exactly what they are supposed to be, we’ve already gone beyond profit in a lot of cases with dividends, and we’ve seen this in particular with oil stocks over the past while. This sector has done terribly over the last few years, but when it comes to paying dividends, we have seen these companies being willing to beg, borrow, or steal to preserve their dividends.

This places the dividends at a higher priority than profitability, and as ridiculous as this may sound, it’s become the reality in many cases, and companies will even be open to placing themselves in real peril by not only being willing to part with money the company needs, they will even mortgage the company’s future over this.

There are oil companies that have borrowed so much to pay dividends that they need oil to rise to $80 a barrel or more to pay for these dividend payments, to not drop a bundle and go into debt a lot more, where amounts lower than this will translate into business losses. When the price of oil drops as low as it has, adding to these losses intentionally and recklessly becomes an act piracy of a very concerning proportion.

It seems that a lot of companies will only part with their dividends as a last resort, and so far, banks have not met that fate, at least yet. There are some very dark clouds on the horizon though, and the biggest concern about this economic paralysis we are in is how banks will be able to manage the big bill that will be coming. Governments will pay their share in the public sector, but banks will ultimately bear the cost of private sector losses, which will be mighty.

Every time a business fails, this means that they have failed to pay back the money that they owe, whether the closure is a result of normal market conditions or due to being forced to board things up and walk away like we have going on now. The banks that this money was owed to have to take the loss, and the buck stops there, all bucks stop there.

The last bastion of help is the government, and we cannot allow banks to just fail, even though we may be willing to allow this to a certain extent. The last time we permitted widespread bank failure, the Great Depression happened as a result. You just spend whatever you need to in order to prevent this, like we did in 2008, and while the mob protested violently, the mob has little clue about finance and did not realize the pain that these bailouts saved them from.

These bailouts are easier for them to understand as this is putting a little money in their pockets as well, although they certainly do not appreciate how limited our response to something like this is, and the great economic gap that is left unaddressed even with the trillions of dollars now being handed out.

None of this serves to address defaults at all in fact, and the best that we can do is bribe companies for keeping people on the payroll with nothing to do, for a brief while anyway. Among those businesses which do go down and do not get back up, banks will foot the full bill here as they are the ones that will be left holding the bag.

Needless to say, this is not a time that banks need to be doing anything with their capital rather than keeping it in reserve to not only facilitate lending, but especially to cover future losses that will arise from this. We cannot afford to have them pay out a percentage of current profit when there will be all these future losses to pay for, losses that are now looming.

If shareholders really were concerned with their companies and their stocks, they should be more than willing to put their companies and stocks first, which turn out ultimately to coincide with their own interests even though they may not be aware, and especially resist the temptation to raid their companies in the face of a crisis like this.

It is not as if dividends are ever a good idea anyway, as this always involves diluting your company’s prospects at best. The idea behind investing, real investing that is and not just owning stock, is to put capital to work in order to build value and wealth.

Paying dividends do not ever make sense, as there are always better options for this money even if there is nowhere else to put it than back in the company’s stock. Just because companies have historically paid out these dividends regularly for years or decades doesn’t mean that this was ever a good idea, and dividends actually function as losses for the company, where the loss is measured by the opportunity cost of the dividends versus growing this capital and providing even better returns to their shareholders, or even to grow the equity of their shareholders if no better purpose can be found.

Dividends are Intrinsically Foolish, and This is the Worst Time to Permit This Foolishness

What this serves to do is to reduce overall return for investors, and we not only know this to be true in theory, we also see it in practice. The trend has been toward lowering or even eliminating dividend payments as a growth strategy, and paying none allows profits to be retained to be used for other purposes, including stock buybacks.

Stock buybacks actually keep the money invested in the company, by using it to increase the value of the shares that we own by concentrating them more. If a company buys back half their shares, just from this one thing, your shares become worth twice as much because you own twice as big of a piece of the company then before this. This means that you make twice as much money from what happens to the business going forward, or lose a lot less in times of trouble.

If there is an opportunity to use the money for capital growth instead, to generate greater profits for the company, that’s the preferable way to go, but if suitable opportunities cannot be found, buybacks keep the money on hand where a company can not only share this profit with their shareholders directly, but have the ability to take it back in the future if needed by issuing more shares, the reverse of a buyback.

Dividend lovers hate buybacks in particular, as they see this as taking money out of their pockets, and don’t realize that they are the ones taking money out of the businesses, and the value of their stocks in turn. Capital outflows from dividends cannot ever be undone, as it is a deadweight loss to the company, something that people who own parts of it should never welcome. They do so anyway, out of pure ignorance.

A good example of how this works would be to look at someone starting out in business that is looking to pay themselves a big salary, one well in excess of their needs, and putting this excess money in a savings account instead of keeping it in the business. This will stunt the growth of your business, and this is a mistake that would be quite obvious to most business owners, but somehow the foolishness of doing this by way of dividends escapes the attention of so many.

When you still want this when your companies are under such intense pressure, in such a huge crisis, this shows how hardy and enduring this ignorance is. Many investors are praying that banks don’t cut their dividends that other companies are starting to do now, and only seem to care about the dividend and not the business or the stock, and do not realize how stupid this is.

The level of ignorance required to maintain this delusion runs very deep. Many of these investors rely on drawing income from their stock portfolios, even though a great many just love dividends for their own sake even though they are not planning on taking redemptions anytime soon.

The people who do require income seem to have never heard of the ability to sell a portion of your stock instead to get these distributions. When even their heroes, such as Warren Buffett, shake his head at this foolishness and tell people straight out that they can just cash in a little as needed instead, you would think that more would catch on to this, but this is a disease that runs too deep for even the patriarch of modern investing to even be able to break through.

Buffett walked away from paying dividends at all over 50 years ago, and his company didn’t just disappear or be thrown into the abyss over this. He was well ahead of his time in this regard, and dividends have become a relic of history to a lot of forward-thinking companies these days, the ones whose stocks go up a lot more over time than the crustier dividend-paying ones, the ones that people are making lots of bread on while high-dividend stockholders are happy to settle for crumbs, or worse.

The easiest way to understand this is that we put our money into companies with an expectation of these companies growing, and they will grow more if allowed to continue to leverage their capital. When we collect a dividend payment, this money is no longer invested and allowed to multiply. Buying stock isn’t investing, but companies re-investing their profits surely is, and companies parting with this money instead is surely de-investing, something that runs counter to the principle of investing itself.

We pay an opportunity cost when this money is taken off the books, whether they re-invest the capital in the business instead or re-invest it in the stock. Our stocks will not grow as much when we siphon off this capital, and the opportunity cost of doing this is greater than the payments we receive instead. This is all simple economics, but thoughts such as this become lost on those so clueless as to think that the only way that they can get paid from stocks is to collect dividends.

While these investors are cheering banks suspending buybacks, it is not because they are concerned about the company’s fates, it is because they are only concerned about their dividends. The most notable part of this is that these are the people who are deciding their company’s fates, and when the financial health of companies, especially banks, get pushed aside in a mad attempt to grab whatever money may be laying on the floor, with no real regard to the price that will be ultimately paid for this, things really start to get scary.

Benefiting from buybacks does not require that you hang on to a stock, as these benefits accrue in real time. When a company buys back stock, the benefits to stockholders are immediate, and they can sell whatever portion of their stock ownership immediately and benefit more financially than the dividend payment that could have been made instead, because this buyback money gets multiplied in the stock market where the added value to the stock price well exceeds the nominal cost of the purchase. This only is transparent if you have some idea of how stocks work though, something dividend investors sorely lack.

This is not a time for either dividends or buybacks, although buybacks would at least keep the money on account with the banks, and would also serve to cushion the big blow that their stocks are taking, something that should particularly matter to shareholders as they watch so much of their investments go down the drain lately.

The Bank of England has wisely asked their banks to suspend dividends, and several major U.K. banks have stepped up to do their part. Given that there is so much more on the line now than shareholders sacrificing future capital gains with their stocks for dividend payments, this is now too important of an issue to be left to the whims of shareholders guided by ignorance.

There may not be a more important time in history for banks to preserve as much capital as they can, and all we have to do is look at the response of the Fed and Congress to get a feel for how dire things have now become.

People worry that a lot of bank shareholders will sell if they stop paying dividends, and that very well may happen, but we cannot put our financial system at risk in order to help them maintain their delusions.

There is always a market for stocks involving going concerns, which these banks will remain regardless of how bad things might get, as they remain the foundation of our economy. If dividend hounds have kept bank stock prices higher than they otherwise will be, and this gets corrected, there will always be investors to step in and take their place, as you have to sell your stocks to someone in order to part with them.

Perhaps bank stocks will then be populated with a higher percentage of investors who actually care more about the fate of the banks and the fate of their stocks, and will actually vote more to see them grow in value, what investing in stocks is supposed to be about.

It would be beneficial to the stock market generally if we prohibited dividends altogether, but we may not wish to be so overbearing with regulation to not allow people enough rope to harm themselves if they wish, provided that the harm is limited to just them. When our own necks are on the line as well, when we are all placed in greater peril as a result of bank vaults being emptied out over this, and especially when we are all subject to paying the bill that this causes, that crosses the line, and we need to not be afraid to step in and do what’s right for the country.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

Contact Ken: ken@marketreview.com

Areas of interest: News & updates from the Federal Reserve System, Investing, Commodities, Exchange Traded Funds & more.