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Big banks' dividend gamble

Regions and Wachovia slash their dividends, but other banks, led by Bank of America, insist they have enough capital.

By Colin Barr, senior writer
Last Updated: July 22, 2008: 2:19 PM EDT

NEW YORK (Fortune) -- The predicted demise of bank dividends has been greatly exaggerated.

Two big banks, Wachovia (WB, Fortune 500) and Regions Financial (RF, Fortune 500), cut their quarterly payouts Tuesday in a bid to conserve cash. The banks join finance-industry titans such as Citi (C, Fortune 500), Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), all of which have cut back on dividends over the past year in a bid to conserve capital against rising loan losses.

But with most of the biggest U.S. banks having reported their second-quarter earnings over the past week, what's striking is how many lenders chose to maintain their quarterly payouts - even as shares in the sector remain battered and worries intensify about a second-half slowdown. For now, the big dividend payouts are helping to lure investors back into financial stocks, after they staged their biggest-ever five-day plunge earlier this month.

On Tuesday, CEO James Wells of Atlanta-based SunTrust (STI, Fortune 500) said his bank doesn't have any plans to cut its dividend or sell common stock, saying a recent sale of Coca-Cola stock gives the bank sufficient capital against future losses. Bank of America (BAC, Fortune 500) chief Ken Lewis went even further Monday, saying BofA will maintain its 64-cent quarterly payout because it's confident of weathering the credit storm.

"The fact that we can absorb $3.6 billion in credit losses, take $1.2 billion of additional write-downs, add $2.2 billion to our allowance for credit losses, and still earn $3.4 billion should tell investors something about the extent and consistency of our earnings power," Lewis said on a Monday morning conference call with analysts and investors, after BofA posted a smaller-than-expected decline in second-quarter profits.

The decisions at SunTrust and BofA to stand pat on their dividends are noteworthy, because analysts have been saying U.S. banks would need to cut dividends and take other actions to raise capital. Goldman Sachs said last month that U.S. banks would need to raise $65 billion to make up for mortgage-related losses.

Meanwhile, the banks' shares have been trading at levels that typically suggest a dividend cut is on the way. As bank stocks hit new lows last Tuesday following the failure of California mortgage lender IndyMac, Bank of America's dividend yield - reflecting its annual dividend rate divided by its share price - exceeded 13%, while SunTrust's payout cleared 11%. In normal times, bank dividends seldom exceed 5% or so.

That's because, as Lewis' remarks suggest, bank executives tend to base their payout rates on the institution's underlying profitability. A dividend rate above about 5% often foretells a cut, by pairing a sharply lower stock price, reflecting investor fears of trouble ahead, with a dividend rate that hasn't come down as much.

A note this week from Bespoke Investment Group in Harrison, N.Y., lists other unusually high-yielding financials including mortgage giant Freddie Mac, which said in a filing Friday that it doesn't currently expect to cut its dividend, and Dallas-based lender Comerica, which said on its conference call last Thursday that it remains comfortable with its current dividend level. At recent prices, Freddie yields 12% and Comerica around 9%.

Obviously, not every bank has held onto its hefty payout. Two other banks that recently sported double-digit dividend yields were Charlotte-based Wachovia and Birmingham, Ala.-based Regions. Wachovia on Tuesday slashed its dividend for the second time in three months, to help fill holes opened by an $8.9 billion second-quarter loss. The bank will now pay a token nickel a share quarterly, down from 37.5 cents last quarter and 60 cents as recently as last year. For its part, Regions posted a second-quarter profit, but said it wants to conserve cash as credit losses rise, prompting it to slash its quarterly dividend to 10 cents from 38 cents.

"In this challenging environment, it is prudent to retain more capital," CEO Dowd Ritter said. "The dividend reduction will retain nearly $780 million of capital annually and significantly strengthen Regions' capital ratios."

And Lewis' comments about BofA aside, not everyone is sold on banks' earnings power, what with house prices still falling and consumer spending slowing. While execs at Citi, for instance, said last Friday they believe the bank can support its reduced dividend payout - the bank currently pays 32 cents, down from 54 cents late last year - analysts such as Oppenheimer's Meredith Whitney and Deutsche Bank's Mike Mayo have questioned whether doing so is a wise use of capital. So even for banks that maintained their dividends this quarter, the question of whether the current payout is appropriate isn't going away.

Still, financial stocks of all sorts have soared in the past week, as fears of another bank collapse have abated and the Securities and Exchange Commission restricted short-selling in some of the biggest names. The rally has brought the yields at BofA and SunTrust, for example, down to 9% - still attractive by historical standards, and seemingly safe, for now.

"But remember," the Bespoke report concludes, "buying financials for their yields is a risky bet these days."  To top of page

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