Colonial Bancgroup Switches from National to State Charter: What Does It Mean?

| About: Colonial BancGroup, (CNB)

I was immediately attracted to Alabama's Colonial Bancgroup Inc. (CNB) because its stock symbol reminds me of "CMB," or Cash Money Brothers, from the classic film New Jack City (where Chris Rock played a crack addict a little too well). Acronyms aside, CNB recently indicated it might switch from a national charter to a state charter. What does that mean? For reasons discussed below, I believe this is good news for people like me, who bought CNB stock for its dividend.

First, it is generally less onerous to operate as a state chartered bank than a federally chartered bank. For example, a state chartered bank can more easily pay dividends than a federally chartered bank. To understand why, we need to go back in American history.

Many of the Founders of the United States viewed the notion of a federally-supervised banking system with skepticism. They had just come from a centralized, tyrannical British system and did not want to grant their federal government equivalently broad powers in the form of money-monopoly. But Alexander Hamilton pushed for a central banking system and in 1791, help set up the First Bank of the United States in Philadelphia, as well as the U.S. Mint (also in Philly).

Perhaps because of the initial difficulty in setting up a centralized banking system, the federal government later passed laws that forced federally-chartered banks to operate under more strict arrangements, creating an Office of the Comptroller and other regulatory banking agencies.

The restrictions on a national (or federally chartered) bank’s ability to pay dividends arise from two statutes: 12 U.S.C. § 60(b) and 12 U.S.C. § 56.

12 U.S.C. 60(b) states:

Approval required under certain circumstances:

A national bank may not declare and pay dividends in any year in excess of an amount equal to the sum of the total of the net income of the bank for that year and the retained net income of the bank for the preceding 2 years, minus the sum of any transfers required by the Comptroller of the Currency and any transfers required to be made to a fund for the retirement of any preferred stock, unless the Comptroller of the Currency approves the declaration and payment of dividends in excess of such amount.

In short, a national bank has to get approval from the federal government if the total of all dividends it declares is more the total of its “net profits,” including net profits from the last two years, and excluding any required transfers to maintain liquidity and pay off higher priority creditors. The point is that there is a restriction on paying dividends that doesn’t necessarily exist under a state charter.

12 U.S.C. § 56 (titled, “Prohibition on withdrawal of capital; unearned dividends”) states:

No association, or any member thereof, shall, during the time it shall continue its banking operations, withdraw, or permit to be withdrawn, either in the form of dividends or otherwise, any portion of its capital. If losses have at any time been sustained by any such association, equal to or exceeding its undivided profits then on hand, no dividend shall be made; and no dividend shall ever be made by any association, while it continues its banking operations, to an amount greater than its undivided profits, subject to other applicable provisions of law. But nothing in this section shall prevent the reduction of the capital stock of the association under section 59 of this title.

Basically, if a federally chartered bank ends up with bad loans, it cannot exclude those loan losses when determining its “net profits.” So if a bank is losing 100 million dollars because of bad loans but makes a profit of 99 million dollars elsewhere, it might not be forced to mark-to-market its bad loans, meaning it might be able to report a net profit of 99 million dollars (oh, pro forma, how Wall Street loved you). However, a federally chartered bank, under that simplified scenario, could not pay any dividends whatsoever.

This § 56 accounting restriction means that in bad years, federally chartered banks would probably have to reduce or eliminate their dividends. In addition, because a federally chartered bank has to pay dividends from “net profits,” rather than some other capital account (“prohibition on withdrawal of capital”), a bank with two consecutive bad years might not be allowed to pay any dividends at all for a long time, even if it is financially healthy overall.

What does this mean if CNB’s application to become converted into a state chartered bank gets approved? I interpret it to mean the hefty dividends are going to keep coming. In the absence of financial irregularities--never a sure bet these days--the state conversion application should be good news for Cash Nabob Bulls, er, CNB shareholders (sorry, Mario van Peebles--I couldn't resist, especially not when you have an economics degree from Columbia University.)

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