U.S. Mid-Cap Banks - Regulators pushing for more dividend cuts

By Goldman Sachs Steven Alexopoulos & Preeti S Dixit

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• Regulators pushing for more dividend cuts. Although we have already seen several rounds of dividend cuts, it appears that regulatory pressure is building that could force sky high dividend payout ratios lower. On November 12, an interagency statement was issued by the Fed, FDIC, OCC, and OTS, providing several guidelines for financial institutions to ensure that banks are supplying sufficient credit to meet borrower demand. One of the notable guidelines was for banks to strengthen capital, with the guidelines specifically indicating that banks should not
maintain a cash dividend (1) that is inconsistent with capital position, (2) could weaken overall financial health, or (3) impair the banks ability to meet the needs of credit worthy borrowers. The guidelines also state that regulators will take action when dividend policies are found to be inconsistent with sound capital and lending policies. Given that only three banks covered their dividend with earnings in the most recent quarter, we think cash dividend levels are about to be slashed.

• Banks most at risk for dividend cut: MI, TCB, BBT, SNV, MTB. Regulators are pointing to adequacy of loan loss reserves, dividend payout ratios and capital position as key metrics banks should focus on in setting cash dividend levels. Ranking the mid-cap banks on this basis, the banks most at risk for a dividend cut are M&I, BB&T, TCF Financial, Synovus, and M&T. Although each of these banks has recently commented that they do not feel a need to cut their dividend, the regulators might see this point differently. The banks least at risk of a cut are CYN,
PVTB, PBCT, and ZION.

• TARP update – capital injections officially replace asset purchases as key use of funds. Shortly after the interagency guidelines mentioned above were released, Treasury Secretary Henry Paulson said in a statement that the Treasury was no longer considering buying illiquid mortgage related assets as part of TARP. Although the potential use of TARP funds for targeted asset purchases remains on the table, capital injections appear to be the most likely use of the remaining $60 billion of TARP funds not yet allocated of the original $350 billion authorized.

• TARP capital approved banks: BBT, CMA, CYN, FHN, MI, RF, TCB & ZION; Still waiting on: CNB, MTB, PVTB & SNV. Eight banks under coverage have been approved for $13.6 billion of TARP capital. We have yet to receive official approval announcements from Colonial, M&T Bank, PrivateBancorp, and Synovus. PBCT does not plan to apply for TARP capital. The remaining banks under our coverage would be eligible for up to $3.5 billion of TARP capital.

• Macro view: Near term downside risks - stay defensive. The economy is in a recession with the question now, in our view, being how deep and for how long. We believe a string of poor economic headlines through year-end will continue to put downward pressure on valuations. Despite that many valuations seem cheap, our view is to avoid getting caught in a value trap. As the valuations become more reflective of the risks, that will be the time to add to or establish positions. At the current time, we continue to advocate a more defensive posture, focusing on names such as PBCT and PVTB, which we think are positioned to take advantage of the
negative impact a challenged economic environment will have on their competitors.

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