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Stock Strategist

Are Bank Dividends Headed Farther South?

Our analysts debate the merits--and drawbacks--of tampering with lofty dividends.

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Last year was a bad stretch for shareholders of many dividend-paying financial institutions. The list of companies forced to cut dividends or raise capital included some of the nation's largest financial institutions, such as  Citigroup (C),  Bank of America (BAC),  Merrill Lynch (MER), and  Morgan Stanley (MS). For companies unable to take action in time, such as  Countrywide Financial  (CFC) and  Bear Stearns (BSC), the mere fear of capital inadequacy led to disastrous outcomes for common shareholders. Additionally, market valuations of banks are down across the board in 2008. Our median price/fair value estimate ratio in the financial sector stood at only 88% as of mid-March, as fears of further housing-related losses kept investors on the sidelines.

In our opinion, depressed valuations in the financial sector may be part of a self-reinforcing cycle. As market prices drop, it becomes more costly for banks to acquire the capital necessary to maintain their health. In the 1930s, the high costs of raising capital led banks to contract lending in favor of less-risky balance sheet assets. A similar phenomenon may well be under way right now. In a speech March 13, Treasury Secretary Hank Paulson announced that the agency was "encouraging financial institutions to continue to strengthen balance sheets by raising capital and revisiting dividend policies."

Jim Sinegal does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.