JPMorgan's Dividend Cut Is a Clever Move

Feb.25.09 | About: JPMorgan Chase (JPM)

While many investors were surprised by JPMorgan’s (NYSE:JPM) move to slash its quarterly dividend from 38 cents per share to 5 cents per share, it is actually a clever decision by the bank’s conservative management in an effort to preserve capital. This allows the bank to prepare for the worst case economic conditions by saving about $5 billion annually.

So, why was the stock trading up after the news was released, and after a week of trading down 19.40%? The answer is that the bank said its first quarter performance to date is “solidly profitable” despite additions to its reserves, and that its quarterly outlook is consistent with analyst expectations of 32 cents per share, on average. The CEO, Jamie Dimon, even commented that for the full year of 2009, “we absolutely see ourselves being profitable.” The company has avoided posting a quarterly loss despite the global financial crisis, although its fourth quarter 2008 profit was a modest $702 million. Therefore, while many may have been surprised by this dividend reduction from the strongest bank, their conservative management is part of what makes the bank so successful and should hardly be seen as jaw-dropping with similar action occurring widely across the sector.

The Better Bank

There are several positives to the dividend cut. The move will allow the bank to repay funds received in conjunction with the Troubled Asset Relief Program more quickly. JPMorgan received $25 billion from the U.S. Treasury under the TARP. This is cash that the bank was urged to take by the government although they did not need it. The conference call given by the CEO may also quell fears that have caused JPMorgan to plummet along with other stocks in the sub-sector. After federal officials announced their strategy for deciding which banks to aid by conducting a “stress test” on their balance sheets, many investors immediately dreaded nationalization. Uncertainty surrounding the degree of nationalization caused stock prices to spiral lower and lower as the week progressed. In the conference call, Dimon said it would prove difficult “to have any stress test that this company won’t pass.”

JPMorgan is a solid long term holding, and one of a few quality options in the Financial sector. Their strong management, healthy balance sheet, and lower international exposure will allow them to outperform their peers. They have certainly done better so far through the economic turmoil, out pacing Citigroup (NYSE:C), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC). In fact, the majority of the reason for their decline is the threats of nationalization facing their peers.

Last month, Bank of America cut their quarterly dividend to 1 cent per share from 32 cents per share, and Citigroup reduced their dividend to 1 cent per share as well with both companies cutting their workforce by 30,000 and 29,000 employees respectively. Wells Fargo has yet to cut their quarterly dividend.

The Good, The Bad, and the Ugly

Although JPMorgan is positioned well for a great future, there are undoubtedly headwinds facing the commercial bank in the near term. The dividend cut is largely a precautionary measure and will definitely provide extra cushion as consumer and commercial loan losses are more than likely to increase over the next quarter. This means that the “fortress” balance sheet the bank is known for will hold up even under extreme economic conditions. The company noted that they will return to a normal dividend payout when conditions in the economy improve.

As previously mentioned, the stock has been hampered most recently by the sector wide fear of nationalization when the Obama administration provided scarce details with its announcement last week of the “stress tests” banks will face. Officials explained this week that possible conditions banks will be asked to use to predict losses on loans include lower housing prices, higher unemployment growth, and progressively contracting GDP growth. There were no specifics given regarding what amount of common equity stakes the government might take, but increased government ownership was an option. The analysis of major banks is projected to take weeks to complete, and the Treasury has been trying to avoid rash decisions based on the volatile stock market. However, if stocks drop so low that interbank lending screeches to a halt, it may force the Treasury’s hand.

After JPM’s stock has been beaten down so much and considering the long term prospects, for what is viewed widely as the strongest bank on the Street, this looks like a good time to buy. While short term market fluctuations are inevitable, especially due to the concerns surrounding the stability of the banking system and the depth of government involvement, this stock is one that is sure to come out on top if investors can stand to stick it out through a bumpy 2009.

-Taylor DeStefano

Disclosure: The mutual fund the author is associated with is long JPM.