Dividends in Financial Services Sector Likely to Be Casualties of Tightening Credit Markets
With credit markets continuing their downward spiral, investors could see their dividends disappearing in 2008.
Dividend cuts or suspensions will continue to pick up among financial services firms in 2008, said Howard Silverblatt, a senior index analyst at Standard & Poor's. In 2007, fewer companies increased dividends, according to Standard & Poor's, while more companies in 2007 than in 2006 actually cut or suspended dividends.
Many investors rely on dividend payments as a source of income, and financial institutions in particular have been rich sources of large payouts. Their need to raise capital in the face of rising loan defaults, though, has made their dividends one of the first places they look to save money.
Diane Merdian at Keefe Bruyette & Woods noted that banks, in general, are offering a dividend yield that is near an all-time high when measured against the dividend yield on the S&P 500. Yields are based on a company's full year of dividends compared to the current share price.
Higher yields indicate the company might be distributing more cash to investors than it can afford. Drastic dividends cuts or outright suspensions are likely steps if companies are struggling with earnings or other cash needs.
Since early July, credit markets have been in a free fall, mostly due to rising defaults on mortgages, especially subprime loans given to customers with poor credit history.
As a result of the rising defaults, investors have shied away from purchasing bonds and debt backed by the loans because of fears of mounting losses. As investors stopped buying the debt, banks and other holders of the bonds have been forced to write down their value.
The writedowns -- which eclipsed $100 billion in 2007 -- have strained earnings, forcing companies to look for new ways to raise capital and preserve cash.
Silverblatt said if the credit markets continue to deteriorate and the economy further weakens, the problem is likely to expand into other areas, such as the consumer discretionary sector.
Additionally, companies that would normally increase dividends each year could also put those plans on hold, Silverblatt said.
The majority of dividend raises usually comes at the beginning of the year, as companies review the last year's financials and prepare for annual meetings. Thus, companies not increasing dividends in the first two months of the year are unlikely to do so later in the year.
One of the country's largest banks, Washington Mutual, said Dec. 11 it will cut its dividend to 15 cents per share from 56 cents per share as part of a broader undertaking to conserve cash.
The dividend cut is likely to save the bank $1 billion. At the reduced dividend rate, Washington Mutual's dividend yield is about 4.6 percent. Had it not cut its dividend, the yield would be about 17.1 percent.
While the dividend cut might save money, investors quickly moved to shed shares of the Seattle-based bank. Washington Mutual shares have declined 25 percent since the company said it was cutting its dividend.
More dividend cuts are likely to come as well. Many analysts are even predicting the nation's largest bank, Citigroup, will have to slash it dividend to preserve capital.
"Citigroup's capital levels are so tight, it might not have a choice," but to cut its dividend, said Josh Peters, editor of Morningstar DividendInvestor. "I wouldn't buy Citigroup today counting on the current dividend rate."
Keefe Bruyette's Merdian said she believes there is a more than 50 percent chance that Citigroup, which spends $10.8 billion a year on dividend payouts, will cut its 54-cent dividend.
She said if it did, the reduction would likely be around 40 percent. Citigroup's dividend yield is currently about 7.7 percent.
The dividend cut is likely necessary because billions of dollars in expected writedowns in the fourth quarter could further strain capital reserves.
Citigroup already took about $6 billion in writedowns in the third quarter, and previously estimated fourth-quarter writedowns would range between $8 billion and $11 billion. In her latest update, Merdian anticipates that writedown is likely to be even larger, at about $15.3 billion.
AP Business Writer Madlen Read in New York contributed to this report.
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