Don't bank on future big dividends

Star Tribune (Minneapolis) (MCT) - The consistent payment of generous dividends has been the saving grace for many a struggling bank this past year.

Still, investors shouldn't get too comfortable. In 2008, financial companies slashed dividends at a pace not seen in more than five decades _ wiping away $37 billion in annual payments to shareholders, according to Standard & Poor's, a New York-based credit rating agency. The slashing is likely to continue well into the new year, say industry analysts, as banks try to hoard capital amid soaring loan losses.

"In this market, you can't count on any dividend check that has a bank's name on it," said Tony Plath, a finance professor at the University of North Carolina at Charlotte.

For now, investors in many bank stocks are enjoying dividend yields at or near all-time highs. The yield is the result of dividing a bank's annualized dividend by its stock price. (For instance, a bank with a stock price of $25 that pays a $1 dividend annually has a 4 percent dividend yield.) A high dividend yield is good for investors because it means they will earn a better return on what they've invested.

For example, the Minnesota-based regional bank TCF Financial is sporting a dividend yield of 7.5 percent, U.S. Bancorp is at 6.95 percent and Wells Fargo is at 4.5 percent _ impressive at a time when many fixed-income investments are posting meager returns.

The average rate on a one-year certificate of deposit is just 2.65 percent, while a 10-year Treasury bond is yielding just 2.1 percent. A high dividend yield can signal that a bank is about to cut its dividend, however. That's because dividend yields rise when stocks fall in anticipation of profit declines.

That's one reason why some analysts question whether U.S. Bancorp and TCF Financial, in particular, can sustain their dividend payments.

Investors who thought those banks' dividends were safe may be disappointed. Rising loan losses and reduced interest income from loans have left banks with less cash, making it harder to rationalize generous dividend payments.

And investors no longer can rely on assurances from bank executives that their dividend payments are safe. In July, Kenneth Lewis, chief executive of Charlotte-based Bank of America Corp., said he "saw no reason to cut the dividend" after the nation's biggest bank acquired Countrywide Financial. Three months later, Bank of America cut its quarterly dividend to 32 cents from 64 cents.

So many banks have cut their dividends over the past year that it's no longer viewed as a huge strike against their stocks. "In 2008, it was the thing to do," said Eric Fitzwater, a financial analyst with SNL Financial in Charlottesville, Va. "We could see another wave if the economy continues its downhill spiral."

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Analysts monitor the "dividend payout ratio," which reflects the percentage of a bank's annual profits that it pays in dividends, as an indicator of its health. Standard & Poor's found that dividend payout ratios have fluctuated between 28 and 40 percent from 1993 to 2006. But after the credit crisis hit in mid-2007, those ratios soared above 60 percent as earnings came under pressure from surging losses on bad loans.

In the third quarter, U.S. Bancorp's dividend payout ratio hit 133 percent, which means it paid out more in dividends than it earned. The Minneapolis-based bank paid out 42.5 cents a share in dividends on earnings of just 32 cents a share.

"No business model can support that kind of dividend," said Plath, the North Carolina professor.

In early December, U.S. Bancorp announced it would hold its quarterly dividend steady. It was the first time in 35 years that the bank, through its predecessor companies, has not increased its dividend.

Analysts say TCF Financial is also entering dangerous territory. The bank distributed 25 cents in dividends per share in the third quarter, while earning just 24 cents per share _ yielding a dividend payout ratio of 104 percent.

Ben Crabtree, a bank analyst with Stifel Nicolaus in Minneapolis, figures the bank will earn $1.02 to $1.16 a share next year, while paying out $1 a share in dividends. "That's not a huge comfort zone," Crabtree said.

TCF's stock declined 24 percent in 2008. That, together with its high dividend yield, suggest that some investors may already expect a dividend cut, he said.

"If it was clear and we all knew that they would continue to pay a $1 dividend, then my guess is the stock wouldn't be as low as it is," Crabtree said.

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© 2009, Star Tribune (Minneapolis)