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In an effort to build capital in the face of an eroding economic and operating environment, JPMorgan Chase & Co. (NYSE:JPM) cut its quarterly dividend from $.38 to $.05. The move was labeled a “precautionary step” and is expected to save the second largest U.S. bank approximately $5-billion annually, while further strengthening its balance sheet and capital ratios.

Chief executive officer Jamie Dimon said in a statement:

While we recognize our tremendous obligation to shareholders to maintain dividend levels, we also understand that extraordinary times require extraordinary measures. Our action today [Tuesday] is being done as a strong precautionary measure to help ensure that our fortress balance sheet remains intact – even if conditions worsen significantly.

Mr. Dimon said the decision is not directly related to TARP, but retaining common equity does help position JP Morgan to repay the government program “as soon as is prudent.”

The move positions the bank for a worst case scenario, according to UBS analyst Glenn Schorr. However, he said JP Morgan’s stress assumptions, which call for 10% unemployment, 40% peak-to-trough home price declines and a two-year recession could ultimately prove not to be the worst case.

The analyst said in a research note:

It also gives JPM greater flexibility to continue to invest in the franchise, take advantage of strategic opportunities, or repay TARP, but don’t expect anything imminent, as we don’t see JPM as ready to give up a relatively cheep capital cushion just yet.

While management’s outlook for the first quarter of 2009 doesn’t appear very different from its fourth quarter results, the lack of any material change may be considered a positive.

Mr. Schorr believes JP Morgan is better positioned than most banks, but left his “neutral” rating and $25 per share price target unchanged given the uncertain environment.

Source: JPMorgan Prepares for Worst Case Scenario, Cuts Dividend