I always thought getting depositors to buy stock in their bank was a win-win situation.
The bank would have a new market for its stock, and since the shareholders were also depositors, they would do more business with the bank, because they would be sharing in the profits.
Therefore I have favored statement stuffers with titles like "Put your money where your money is" to get depositors interested in a stock purchase.
But recently I heard of a dilemma that puts the value of these programs in doubt.
One of the units at a bank I know has had serious problems, which have led to a sharp drain on earnings. The bank might be better off cutting the dividend in order to save as much capital as possible while it recovers.
But when an analyst I know questioned the head of the bank as to why the dividend was not cut, the banker said he did not want to alienate shareholders who are also depositors.
If the dividend were cut, many customers would be unhappy, the banker said. This would lead to serious loss of business. Therefore, he said, the bank had to "hang in there" until earnings levels improve.
Some readers may think this issue is academic, because dividends do not mean so much to investors these days.
For example, the May 22 American Banker article "Banks' Love for Dividends a Lonely One" emphasized the fact that most institutional investors are not that interested in dividends. With the tax situation the way it is, many holders focus on capital appreciation, which avoids the double taxation of bank income, rather than dividends.
As for dividends serving as a sign of solvency, many investors have developed other means to assess a bank's strength.
But is this true for community bank shareholders? The dividend is the basic reason many of them hold the stock. They have no intention of selling it, and they count on the dividends to help maintain their lifestyle. A dividend cut can be a real tragedy to them.
Since CDs and savings accounts provide minimal growth potential, and most other stocks seem riskier than bank issues, shares of the local bank appear to offer the best combination of growth potential and income.
What can community banks do?
Certainly those that are facing earnings problems would be well advised to survey their shareholders to find how important the dividend is to them. Then if trouble arises, at least they will know how dangerous a cut would be to their business.
Surveying shareholders would also help a bank determine whether to raise the dividend as earnings rise. If dividends are not important to most of shareholders, the bank could retain more earnings as a cushion against trouble.
Mr. Nadler, an American Banker contributing editor, is a professor of finance at Rutgers University Graduate School of Management in Newark, N.J.
