Last Updated: March 28, 2008: 12:29 PM EDT
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Whitney: Citi to cut dividend again

Analyst predicted the bank's first cut, but has she stumbled with latest prediction?

By Katie Benner, writer-reporter

Oppenheimer analyst Meredith Whitney.

(Fortune) -- Weaker-than-expected earnings will force Citigroup, Wachovia, Bank of America and Wells Fargo to cut their dividends this spring, says Oppenheimer analyst Meredith Whitney.

"Our argument is simple. Banks under our coverage are dangerously approaching earnings levels that simply will not support such high relative payouts," Whitney wrote in a report released Friday.

"Beginning with 1Q08 results, to be reported in two weeks time, banks will seriously address their ability to maintain their current dividend levels."

Last October, Whitney made a name for herself by correctly predicting that Citi (C, Fortune 500) would have to slash its dividend and sell assets so that it would have enough Tier 1 capital, the amount of cash a bank must have on its books in order to meet regulatory requirements. Since that report, she has made several other correct and bearish calls on the state of the financial sector.

The dividend issue is particularly important for investors and the broader market now because, at a time when financial stocks have been hammered, many investors are holding onto them simply because they pay such rich dividends. Bank stock dividends currently are hovering at an average of 6%, the highest since 1990, which some believe is a decent consolation prize for those waiting for the stocks to recover.

But if dividends are cut due to ailing financial health, investors who have been patient holders may dump the stocks.

To cut, or not to cut?

Whitney's argument is two-fold: First she points out that the biggest banks hold structured bonds that have all been downgraded by the ratings agencies. In fact, Moody's, Fitch, and S&P have downgraded about $370 billion in securities and are racing to find and downgrade more hidden shaky paper.

Rules require banks to hold more capital in reserve against assets with lower ratings, so it follows that the banks will have to increase their Tier 1 capital levels.

Second, Whitney says because of the increased write downs on these bad assets, earnings will be substantially lower than anyone has so far estimated.

"For example, we estimate that Citigroup will actually earn $1.43 per share shy of its dividend payment this year. In other words, C will pay out $1.43 per share more than it earns this year. How anyone, let alone C's management and the board, can believe that its dividend is safe given this earnings scenario is beyond our comprehension," she writes.

Bank of America (BAC, Fortune 500), Citigroup, Wells Fargo (WFG) and Wachovia (WB, Fortune 500) all declined to comment on the report.

However, it should be noted that Citi has been acting aggressively to address its precarious capital position. According to its annual earnings report filed this February, it has raised $30 billion in qualified Tier 1 capital since last November (which is the same amount Whitney said back in October that Citi would need).

At this point it looks like the bank is marginally overcapitalized. As it points out in its annual report, "To be 'well capitalized' under federal bank regulatory agency definitions, a bank holding company must have a Tier 1 Capital Ratio of at least 6%, a Total Capital Ratio of at least 10%, and a Leverage Ratio of at least 3%." According to that report, it has a Tier 1 ratio of 7.12%, a total capital ratio of 10.7%, and a leverage ratio of 4.03%.

The bank is also taking further steps to sell assets, which would reduce the amount of Tier 1 capital it is required to have.

Citi's numbers may look strong, but let's remember that ex-CEO Charles Prince was adamant last fall that its dividend was safe. It slashed that payout to shareholders by 41% in January.

And with the stock down more than 2% after Whitney's pronouncement, it looks like investors have put their money on her. To top of page

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