WSJ: Loyalty Pays a Bitter Dividend

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• OCTOBER 1, 2008

Loyalty Pays a Bitter Dividend

By E.S. BROWNING

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Grace Pace, a 72-year-old widow, says her husband invested years ago in a local bank in Biloxi, Miss. Over time, that tiny bank was acquired and re-acquired, until it became part of giant Wachovia Corp. Still, Mrs. Pace and her husband, a Biloxi physician, held on: It was a point of family pride to have a stake in the local bank.

Grace Pace

On Monday, the day Wachovia was broken up in a forced sale to Citigroup, Mrs. Pace was in tears. Wachovia's dividend once provided a third of her income. That money is now gone. "You just think, 'This can't be happening,'" she said. "What is secure any more?"

Mrs. Pace said her son recently reassured her that if things get really bad, she can move out of her home and into his basement, which has a window. Then she began to cry again.

Variations of Mrs. Pace's story are playing out in households nationwide. The financial crisis is overwhelming some of America's most loyal investors: individuals who've held on to bank stocks for years or even generations.

After World War II, as the American middle class embraced stock investing, hometown banks were often a first choice. The honor of bank ownership became a part of small-town mythology, expressed in movies like "It's a Wonderful Life," the holiday-season fixture about a beloved local banker and his guardian angel.

In the decades after the Great Depression and the bank failures of the 1930s, financial stocks rebuilt their prestige and earned investor confidence as the industry became a major part of the nation's blossoming service economy. Banks now employ 2.2 million people -- more people, and at higher wages, than McDonald's Corp. (whose restaurants employ 1.6 million world-wide).

Families often hesitated to part with bank shares that spouses, parents or grandparents had accumulated, even as the nature of the original institutions changed almost beyond recognition. By June 2007, ordinary individuals and small institutional investors owned roughly $750 billion in the stock of financial institutions, according to Thomson Reuters.

By the end of June 2008, however, individuals' holdings in financial stocks had fallen by $380 billion -- more than half their value. Values have fallen further since then, of course.

EPA/Justin Lane

Two women enter a branch of Wachovia bank in New York. Wachovia was taken over by Citigroup in a deal brokered by the FDIC.

In the first half of this year, bank-stock dividends fell by $35 billion, or 53%, according to the Federal Deposit Insurance Corp. Roughly a quarter of that stock was held by small investors, according to Thomson Reuters, meaning they lost $8.8 billion in dividends in six months. Retirees are often particularly reliant on dividends for income.

The faith of long-term holders is now being punished. Joe Thompson, whose grandfather helped found a bank in Winamac, Ind., that later became part of KeyCorp, describes the stock, which his family still owns, as "the family heirloom." Today, it is in a trust he manages for his 89-year-old mother. But the share price has fallen 70% since early 2007, and the dividend has been halved.

Similarly, Sidney Berry, a retired obstetrician in Tennessee whose father invested in the hometown Lebanon Bank back in the 1950s, has lost tens of thousands of dollars. Still, he can't bring himself to sell.

"I think about my father buying stock in the Lebanon Bank 50 years ago, and owning the stock all that time," said Dr. Berry, 63. "I do have something of a sentimental attachment to it."

Of course, one of capitalism's bedrock rules is that when a company struggles or fails, its owners -- the shareholders -- bear the heaviest losses. Still, from the perspective of some of these conservative, long-term investors, the burden has fallen unfairly on the little guy.

Some, including Dr. Berry, question how trusted community bulwarks were allowed to become speculative enterprises that behaved more like Internet stocks, and wonder why no one is being held responsible. He points a finger at the often highly paid executives who ran the failed firms. "It seems like they soak the shareholders and take off with a lot of money," Dr. Berry said. "I don't know why boards let CEOs do that kind of thing."

Until recently, financial stocks seemed like a good bet. After the 2001 recession, financial-company profits rose to account for more than 2.5% of gross domestic product from less than 1% in the 1980s. Financial stocks replaced tech stocks as the market's largest single group, in terms of market value. (Although now, due to the financial crisis, they've swapped positions again.)

Few investors realized the danger that accompanied banking's heady growth. Once-stodgy institutions were dabbling in exotic new securities based on high-risk mortgages, leaving them exposed when the housing bubble collapsed.

Mrs. Pace, who took a hit from Wachovia's breakup, was married to a Mississippi doctor who strongly believed in local banks. "He had a very emotional tie to the bank stocks," Mrs. Pace recalled. "He felt they were perfectly safe."

He bought shares in a local Biloxi institution called First Jefferson. First Jefferson was bought in 1994 by SouthTrust Corp. of Alabama, which in turn was bought by North Carolina's Wachovia in 2004.

Mrs. Pace sold some shares after her husband's 2003 death. But by 2006, nearly half her stock holdings were in banks, mainly Wachovia.

Her investment adviser and others urged her to diversify more. While she was nervous owning so much of one stock, she points out that her income is primarily Social Security and dividends -- and Wachovia "was the best dividend producer that I owned," she said.

Wachovia closed Tuesday at $3.50, down 94% from a recent high in February last year.

She moved to Hendersonville, N.C., into what was once the family's vacation home. Previously, she lived in a condo nearby, but now is trying to sell it to restore her nest egg.

"This was how we were going to fund our retirement," Mrs. Pace said, "We were going to have real estate, and we were going to have stocks." Now both are in trouble.

A Part of Life

For Dr. Berry of Columbia, Tenn., owning bank shares was a part of life, starting with his father's investment in Lebanon Bank more than a half-century ago. In 1987, First Tennessee National Corp., a Memphis bank with big plans, acquired little Lebanon Bank for $31 million in stock. First Tennessee (which in 2004 changed its name to First Horizon National Corp.) expanded into more than 40 states, selling mortgages and home-equity loans into the booming housing market.

Last year, Dr. Berry faced a tough decision. With the stock near its highs, his sister, Letitia Hudlow, who also inherited stock from their parents, decided to sell it and diversify her portfolio, and she urged her brother to do the same.

Dr. Berry says he just couldn't sell their father's stock. He told his sister, "I think I am just going to hang on to it and see what happens," Dr. Berry recalls. "What happened was, it went down to about 20% of its value very quickly, and stopped paying dividends."

A Nashville television station broadcasts local stock prices during the evening news, and Dr. Berry watched First Horizon's shrivel. He and his wife would discuss what to do.

"The halfway point was an attention-getter," he said. At $22 a share, which it hit late last year, the stock had fallen about 50% from its 2007 high of $45.13. "I didn't want to sell low, so I didn't -- but it went way below that."

On Tuesday, First Horizon finished at $9.36 a share, down 79% from that 2007 high.

With mortgage markets in crisis and defaults mounting, First Horizon has sold its mortgage business outside Tennessee, announced plans to replace its chief executive and, in a June letter to shareholders, said it would pay its third-quarter dividend in stock rather than in cash.

"I fear that they are just diluting the value of the stock itself, so that the stockholders aren't really getting anything of value" from the dividend, Dr. Berry said. Until the bank ran into trouble, it had been paying a dividend of about 5%.

First Horizon acknowledges that its stock dividend doesn't have financial value, since it is akin to a stock split, but says some shareholders find the additional shares useful.

It defends its business strategy. "Our national expansion served us well for a certain period of time through the 1990s and part of the 2000s," said David Miller, senior vice president for investor relations and corporate strategy. More recently, however, "The strategy had to change, so we have changed it very aggressively."

Dr. Berry says he has other income and that his lifestyle hasn't been affected by the loss of the dividend. But he occasionally finds himself wondering whether he might have to resume his medical practice if he faces a further financial setback.

"I can see how a retired person whose retirement is dependent on one particular stock -- how a reversal like this could make them consider going back to work," he said.

Bank stocks have been among the hardest-hit of the financial shares. The Dow Jones Wilshire index of U.S. bank stocks was down as much as 60% in July from its record high. On it was down. Some banks, such as National City, have been down more than 90% at their lows. Another, Washington Mutual, has been subsumed into J.P. Morgan Chase & Co.

Delayed Retirement

Some people are being forced to delay retirement. Joan Makowski, a 27-year Merrill Lynch employee who was widowed late last year, hoped to ease into retirement by working part time next year. Her retirement savings included a big holding of Merrill stock. With that stock down 74%, her savings are down $150,000 and she has abandoned hopes of retiring soon. "I now worry for the first time in my life about money," she said.

As a financial manager, she knew she shouldn't keep such a big holding of one stock. But as a Merrill employee, she never imagined her employer could suffer so badly.

"I was so proud to work for Merrill Lynch. I thought I would never have anything to worry about," she said. "I am just glad I didn't work for Bear Stearns." In March, Bear Stearns Cos. was absorbed into J.P. Morgan, making Bear Stearns one of the first major Wall Street firms to succumb to the financial crisis.

Merrill has agreed to be taken over by Bank of America at a higher price than Bear Stearns shareholders received.

Mr. Thompson, whose grandfather helped found the bank in Winamac, Ind., recalled that his father wouldn't consider selling the inherited stock. His dad felt an obligation to his family, and to the town, Mr. Thompson said.

After his father died in 2006, Mr. Thompson and his mother diversified by selling half the shares. They kept the other half, which by then were in KeyCorp.

This year, Mr. Thompson, who heads two small Florida biotechnology companies, had to tell his mother that KeyCorp had taken a hit. "I said, 'You know, these bank stocks are not doing very well,'" Mr. Thompson says. But he assured his mother that that their financial adviser was able to rearrange the trust's holdings so her income wouldn't change.

"She said, 'Are we going to sit tight?'" Mr. Thompson recalls. "And I said, 'Yes, we'll sit tight.'"

As they spoke, he says, he realized that many of the residents of her retirement home were also discussing the bank-stock debacle. "A lot of them were affected by it," Mr. Thompson said.

—Shelly Banjo contributed to this report.

Write to E.S. Browning at jim.browning@wsj.com

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