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Dilution Risk: Stock Awards Are Just The Beginning


As employees receive restricted stock awards for compensation, keep an eye on bank stock share counts.

This morning, the financial media are reporting that many highly compensated employees of financial service firms will be receiving large portions of their total 2009 compensation in restricted stock; however, unlike prior restricted stock awards, the 2009 awards will vest very quickly -- in April for employees of Citigroup (C) and August for employees of Merrill Lynch.

I highlight this for two reasons.

First, for the employees involved, I would offer that in addition to whatever their normal day job is, they now wear a second hat that I can only describe as "syndicate member". Given the short vesting time frames, they have effectively "bought stock for resale" -- not unlike what a stock underwriter does every day. Admittedly, they were forced into the role, but that's the job. And everyone should see it for what it is.

Second, I'd strongly encourage Minyans to watch bank stock share counts. In the old days of restricted stock awards and option grants, companies would normally go into the market and repurchase an offsetting amount to avoid shareholder dilution. I strongly doubt that that will be the case this year. The net effect of this is that compensation "expense" will end up being offset by an increase in capital, albeit at the expense (again) of existing shareholders.

Earlier this week I highlighted on the Buzz that Alcoa (AA) was issuing stock to its defined benefit plans to reduce its unfunded pension liability. That was the same kind of transaction, although in that case it was former employees who joined the syndicate (albeit likely for an even shorter period of time).

But as I have been saying for sometime, "stock is the new cash", and until existing shareholders revolt, companies, particularly under-capitalized companies, are going to do it over and over and over. And as I have offered previously, no one seems to have factored this into 2011 P/Es.

Today, no one seems terribly worried by the use of company scrip to settle liabilities, but that is because there are liquid markets. But as more and more employees, former employees, bondholders, and dare I suggest principal suppliers are "voluntold" to take stock, I can't help but wonder how long it will be before existing shareholders understand the game, and they too decide to play along.
Position SPY options, SRS and JPM
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