Expect BofA's Dividend To Be Cut

Will Bank of America (BAC) cut its common dividend, now yielding a hefty 8.87%?  

In recent comments to investors, the company repeated earlier assurances that it sees “no reason” to cut the dividend, unless the U.S. economy “deteriorates significantly.”  This is nonsense, in my opinion.  Past and pending acquisitions have stretched BofA's capital base. The economy, as well as the company's earnings outlook, continue to worsen. The dividend needs to be cut, and will be, in my opinion, probably by about 40%.

Recall that last year, Bank of America acquired LaSalle Bank from ABN-AMRO for $21 billion cash.  It also paid $3.3 billion in cash for U.S. Trust, in a deal that closed on July 1.  Last July, BofA hiked the common dividend payout 14.3% to 64 cents, from 56 cents. Last August, it famously invested $2 billion in Countrywide (CFC) preferred.

This year, BofA agreed to purchase the rest of Countrywide for $4.1 billion in stock.  As CEO Ken Lewis never tires of reminding us, Bank of America is big. But these serial acquisitions, along with deteriorating earnings performance and a higher dividend payout, have pushed the company's tangible equity to asset ratio to below 4%.  Since December, BofA increased its Tier 1 capital by selling nearly $14 billion in convertible preferred stock priced to yield 7.25%. The cash dividend on its preferred will approach $1 billion this year, compared to $180 million in 2007.

In 2008, I expect that Bank of America will report earnings of about $11.3 billion or $2.53 per share. (Consensus estimates are presently $2.68 and $3.86 for this year and 2009, respectively.)  The cash outlay to service the common dividend will come to $11.6 billion, a dividend payout ratio of 103%.  Next year’s earnings may be better, but analysts’ estimates tend to trend lower over time. If EPS are $3.50, the dividend payout ratio will be about 76%, well in excess of BofA's typical 40-50% target.

Sources tell me that the C-suite has ordered costs curtailed across all business lines, especially to prevent a cut in the common dividend.  In my view, this short-term strategy may have public relations benefits, but it carries unfortunate long-term consequences. Expense cuts are likely to hurt performance at recent acquisitions and adversely affect BofA's other businesses as well.  For example, U.S. Trust customers, long accustomed to an expensive level of service, may be inclined to seek private banking services at other firms should they see corners being cut. And we have yet to see how well Countrywide’s operations and balance sheet will be melded into Bank of America’s.

There is little question that Bank of America is well-capitalized for regulatory purposes and could continue to pay its common dividend even at high payout rates.  But that's neither affordable nor financially wise, and may diminish the company's ability to maintain and grow its customers and business.  There are plenty of reasons to expect a dividend cut.

Comments

[Jason98758:]

The common stock dividend is Ken Lewis' Alamo. If he cuts it, that could be the final straw for his tenure because investors would ramp up their pressure.

2008 Jun 13 08:41 AM

[User 209734:]

It's valid to question any bank's hefty dividend payout. However, the article is not entirely balanced analysis.

It's also important to more closely examine the profit streams going forward; and, some profits should increase. Examples include profitability on deposits as yield curve steepens, increased mortgage lending profits from cfc aquisition (good underwriting, of course), investment banking (increased market share from troubled competitors), mutual fund assets growth (columbia funds), etc.

2008 Jun 13 10:26 AM

[cocomurph:]

Don't bet the farm on a dividend cut! ;-)

2008 Jun 13 10:54 AM

[TA:]

There's been plenty of reasons for a cut since last August. Will it be cut now, 2 months from now or next year, who knows?

Maybe I should ramble on about speculation based well known info and publish it in SeekingAlpha like this author.

2008 Jun 13 03:49 PM

[insane_equine:]

I completely disagree!
There is very little chance that BAC will reduce the dividend, especially in view of the chairman's direct comment when asked about this exact possibilty.
A dividend cut at this point would so erode investor confidence in BAC that irreparable harm would result.
Fear over the Countrywide acquisition is unfounded. BAC has protected itself from loss in a prior arrangement and positioned themselves admirably for the future.
I have more concern over the MBNA merger, which could result in major credit card losses in a severe economic downturn, though in that case we are ALL in trouble.
At its current price I consider BAC to be a bargain to be held over the long term.

2008 Jun 14 10:25 AM

[Mindstorms2002:]

Mr. Townsend,

BAC has said that there are viable capital raising alternatives to reducing the dividend. Do you have a feel for what they are and if they are in fact "viable." Also, do you have an opinion on the how the stock price will act over the next 12 to 18 months if the dividend is reduced 40% and other capital raising strategies are implimented (i.e. partial liquidation of CCB, etc.).

Thanks.

2008 Jun 14 01:56 PM

[Donald Johnson:]

I recently bought BAC July covered calls because of it's high yield and Morningstar.com's five star rating, which is based on an estimated fair value of $56. My position would yield close to 18% annualized, if I could roll it over at comparable cc returns and the dividend weren't cut. M* says there is a 52% chance the dividend will be cut. That's pretty well baked into the current price, imo, and even with a 50% dividend cut, selling out of the money calls yields a nice return until the stock recovers.

I blogged on my site on this trade about a week ago.

What's wrong with this strategy?

2008 Jun 18 09:13 AM