A series of 10 percent stock dividend issues to Butterfield Bank shareholders during its years of soaring profits had the effect of boosting the value of senior management's stock options.

That is the view of one source with inside knowledge of the bank, who believes boosting of executive wealth may have been the rationale behind the stock dividends, which happened six times between August 2001 and March 2008.

In an efficient market, each time the bank issued a 10 percent stock dividend, the bank's share price should have fallen by about 10 percent, because of the dilutive effect of the newly issued stock.

Bloomberg data of the bank's trading price on the Bermuda Stock Exchange show that a 10 percent correction did not even come close to happening on any of the six occasions in the week following the ex-dividend date.

According to the source, the trigger prices on executives' stock options were lowered by 10 percent to account for the stock dividend payments. So those in the stock option plan benefited greatly from each of the special stock dividends. The source believed the bank's management had been frustrated with Butterfield's share price trading below book value in the 1990s.

"A lot of their shareholders were wealthy people holding their stock and living off the dividends," the source said. "So when they gave the 10 percent stock dividends, it was unlikely that there would be much selling.

"And if people did start to sell, they had a big share buyback programme they could use to mop it up." During the eight years from the start of the decade to the end of 2007, Butterfield Bank shares produced a return, including dividends, of 27.3 percent annualised.

According to the source, the steep rise in the share price meant it was trading at close to three times book value at one point - a higher multiple than a bank would normally warrant, he added. Profits soared through this period and peaked at $146 million in 2007. The bank was consistently topping its target of 20 percent return on equity (ROE).

ROE is often seen by business observers as a good measure of success - what it does not reflect is the level of risk the company is taking to achieve that ROE. The source believed the determined effort to achieve the high ROE target was a significant factor in the bank's turn for the worse as it took on extra risk to achieve the goal.

Through its successful years the bank had been levered at a ratio of around 20:1. That meant Butterfield had 20 times as much in assets on its balance sheet as it did in shareholders' equity. Assets include the bank's cash, investments and loans owing.

So to achieve the 20 percent ROE, Butterfield had to make a net one percentage point return from those assets.

The source said this was more safely achievable when spreads - the difference in interest rates - between what Butterfield could borrow money for from other banks and what it could make by investing it were wide. When those spreads started to narrow some six years ago, the 20 percent target became more difficult to achieve. But taking on more risk was a serious business, when a five percent loss on assets would effectively wipe out shareholders' equity.

And after Butterfield poured money into US mortgage-linked securities, it was the shareholders who ended up paying a heavy price.