On February 24, the Board of Governors of the Federal Reserve System (Federal Reserve) issued a supervisory letter (Letter) intended for distribution to all entities regulated by the Federal Reserve. The letter, SR 09-4, advised bank holding companies (BHCs) and state-member banks to use care before declaring dividends, particularly with respect to trust preferred securities, or repaying outstanding debt obligations, if such entities have received assistance under the Troubled Asset Relief Program’s Capital Purchase Program (CPP). While the guidance issued under new SR 09-4 largely restated existing Federal Reserve guidance with respect to preserving the holding company as a source of strength, the Letter also stated as follows: “[A] recipient of taxpayer funds through [new governmental capital programs such as the CPP] should consider and communicate reasonably in advance to Federal Reserve supervisory staff how the BHC’s proposed dividends, capital redemptions, and capital repurchases are consistent with the requirements applicable to its receipt of capital under the program and its ability to redeem, within a reasonable period of time and with Federal Reserve consent, its outstanding capital issuance under the program. While not expressly prohibited, BHCs are discouraged from using proceeds of the CPP or other public investment to pay dividends on trust preferred securities or repay debt obligations. If the financial condition of a CPP or other program participant deteriorates significantly, it may be appropriate for that BHC to cease paying dividends on the investment, as well as on trust preferred securities. Likewise, participants in such programs should ensure that stock redemptions and repurchases are consistent with program requirements and, if permissible, are consistent with redemption of capital issued under the program as soon as reasonably feasible and appropriate.”  

Under the standard terms of the CPP, so long as dividends are current on outstanding preferred stock issued to the U.S. Treasury Department, dividends to existing shareholders are not prohibited. It is not clear at this time whether the Letter is intended, via regulatory fiat, to change the terms of the CPP documents. Consultation with the Federal Reserve is therefore recommended on an individual institution basis.