Should we punt or go for it? The question that has taunted football coaches since the inception of the game now taunts Bank of America (NYSE: BAC ) with regard to its dividend.
Can and will B of A maintain its dividend, currently yielding an eye-popping 8.6%? Or will the bank go the way of Citigroup (NYSE: C ) and Wachovia (NYSE: WB ) and cut the dividend to save some much-needed cash? Last week, B of A CEO Ken Lewis said the dividend is safe. But can investors believe him?
Well, let's look at the numbers. Bank of America's dividend is currently $2.56 per share, for an 8.6% yield. The 2008 consensus analyst estimate for the bank's earnings is $2.66 per share. That means that to keep the dividend, the bank will have to pay out virtually everything it earns. Put another way, that's nearly a 100% dividend payout ratio, compared with the bank's historical payout ratio of 40% to 50%.
Credit losses at the bank, although not nearly as bad as those at UBS (NYSE: UBS ) and Citigroup, were $6 billion just last quarter. The slower business environment has taken its toll on earnings, as have a string of recent acquisitions. Just last year, B of A acquired LaSalle Bank and U.S. Trust, and this year, it agreed to buy out Countrywide Financial (NYSE: CFC ) . These recent acquisitions cost the company nearly $30 billion.
Lewis says he "views the dividend as safe" and is "cautiously optimistic on the economic environment." Sure, the economic environment could get better. If it does, several major banks are worth buying at current prices. But what if things don't get better? What price will B of A pay to maintain that lofty dividend?
Keeping the dividend where it is in a deteriorating environment might cause the company to rob from tomorrow's stock performance. Using so much badly needed cash to pay the dividend could force the bank to find money from other sources and increase the debt burden for many years to come. That situation could force the company to pull back business, lose market share, and dilute shareholdings with stock offerings. Already the bank has issued some $14 billion in convertible preferred stock since December.
The current 8.6% is a juicy yield for sure. It would be a beautiful thing if you could collect 8.6% on a great bank that's beaten down while you wait for the price to come back. But there is a point at which it makes more sense to cut the dividend. Will B of A reach that point? Will it choose to cut if it does reach that point? We'll see.
Cutting a dividend is always ugly. The stock price usually takes a hit, and a company loses credibility with shareholders. However, if the bank makes poor decisions about the future just to maintain the dividend, the dividend might be all you'll get from holding the stock in the future.