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More big bank dividend cuts lie ahead

After a sharp selloff, BofA, Wachovia and other high-yielders may need to cut their payouts before long.

Colin Barr, Fortune Senior Writer
Last Updated: June 17, 2008: 11:05 AM EDT

Shares of several big banks, such as BofA, Wachovia, Fifth Third and Regions Financial, have plunged in the past year. And that's led to speculation of dividend cuts.

NEW YORK (Fortune) -- Falling bank stock prices are a warning to investors not to get too attached to those fat dividend checks.

The latest struggling lender to sock shareholders is Cleveland-based KeyCorp (KEY, Fortune 500), whose shares tumbled 24% Thursday after the bank said it would slash its quarterly dividend in half to conserve $200 million annually.

But with inflation worries driving up interest rates and house prices still tumbling, the market is betting Key won't be the last bank to cut its dividend. Unusually high dividend yields could point to coming dividend cuts at banks ranging from giants Bank of America (BAC, Fortune 500) and Wachovia (WB, Fortune 500) to regionals such as Fifth Third (FITB, Fortune 500) and Regions Financial (RF, Fortune 500).

The yield is the result of dividing the annual stated dividend payout by the current stock price. A higher number is typically better for investors, of course, because it means a bigger income stream relative to how much they've invested.

But in a credit crunch-obsessed market, a high dividend yield can actually be a warning signal. That's because an increase in the bank's dividend isn't the only factor that can cause the dividend yield to rise. So can a decrease in its stock price.

And with banks facing sharply reduced earnings prospects due to rising credit losses and tightening lending standards, a high yield can spell trouble ahead.

Gary Townsend, CEO of Hill-Townsend Capital in Chevy Chase, Md., says bank stocks historically have yielded in the range of 3% to 4%. So any stock with a yield in the high single digits can be viewed as a candidate for a future dividend cutback.

"When you get to about 8%, that speculation becomes quite pronounced," says Townsend, a former Wall Street bank analyst.

Which banks are in danger?

Some of the big banks with yields around that level include Bank of America, which as a yield of almost 9% and Wachovia, whose recent price swoon has left the stock yielding more than 8% even after a dividend cut in April.

Other candidates for dividend cuts include double-digit yielders Fifth Third of Cincinnati, which yields 14% after Friday's double-digit selloff; Regions of Birmingham, Ala., which yields 11%; and U.K.-based Barclays (BCS), which recently yielded 13%.

For now, the banks aren't signaling any intention to cut their dividends. Representatives from BofA, Wachovia and Regions didn't immediately reply to requests for comment.

A Fifth Third spokeswoman says the bank doesn't comment on market speculation about its dividend and notes that decisions about the dividend are made by the board of directors, which is meeting today.

Barclays, which isn't due to make a semiannual dividend declaration until August, told analysts on a conference call last month that it hadn't made a decision on its payout.

"We're active managers of capital and we have a range of options. We're explicitly keeping all of them open today," finance director Chris Lucas said back on May 15. "We're aware of the importance that shareholders place on dividends."

To be sure, not every bank is cutting back. CNNMoney's Paul R. La Monica recently rattled off a list of banks whose cautious underwriting and conservative financing means their dividends are probably safe.

But no one is immune from scrutiny, given that even banks that have already reduced their dividends have, under stress, gone on to do so again.

Washington Mutual (WM, Fortune 500), for instance, cut its quarterly dividend to 15 cents from 56 cents back in December. WaMu then cut it again -- to a penny a share -- in April when it sold a big stake to a group led by private equity firm TPG.

Not everyone believes a big dividend yield points to a future cutback though.

Oppenheimer analyst Meredith Whitney, who was the first Wall Street analyst to predict (correctly) a dividend reduction at Citi, said last week that a chat with BofA chief Ken Lewis led her to conclude Bank of America's dividend was safe.

Lewis later said that while he hasn't explicitly defended the bank's current dividend, which runs $2.56 a share annually, he thinks the bank would only reconsider its payout if the economy suffers a sharp slowdown - an outcome he doesn't foresee.

Analyst: Credit Trends 'Are Quite Negative'

But Townsend wrote last week at the Web site that he expects BofA to cut its dividend by about 40% later this year to reduce the strain on its capital base.

Townsend points to another dividend number - the bank's profit payout ratio, which reflects the proportion of annual earnings the bank sends out to investors as common dividends - as supporting that analysis.

He estimates BofA will spend all its projected net income this year and nearly three-quarters of its profit next year on common dividends - a trend he calls unsustainable. "The market is of a mind this dividend is too high," he says.

The dividend yield and the earnings payout ratio aren't the only numbers to consider either. Banks that have raised capital via preferred stock sales - such as Citi and Bank of America -- also agree to issue preferred dividends. And those must be paid out before any common dividends can be paid.

Finally, with house prices falling, mortgage defaults on the rise and employment growth weak, credit trends right now "are quite negative," Townsend says.

That gives banks another reason to be careful about not paying out too much in dividends -- and shareholders in high-yielding bank stocks another cause for concern. To top of page

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