Citi's Dividend Dilemma
Another day, another drubbing for Citigroup (C). The financial giant took yet another hammering from investors on Dec. 27 after Goldman Sachs (GS) boosted its estimate of Citi's asset writedowns for the fourth quarter by 70% and predicted the firm would have to cut its dividend by 40% in 2008 to preserve capital.
Equity analyst William Tanona at Goldman more than doubled his projected per-share loss for Citigroup to $1.33 from 52¢ in the fourth quarter and said he now expects write-offs related to collateralized debt obligations, or CDOs, to be $18.7 billion, vs. a prior estimate of $11 billion.
He also cut his 2008 and 2009 earnings estimates for Citi, saying that about $25 billion in remaining exposure to CDOs after the fourth quarter's write-offs will force the firm to raise an additional $5 billion to $10 billion and cut its dividend next year. (Goldman Sachs has provided investment banking services for Citigroup within the past 12 months and expects to provide them within the next three months.)
The expectation that Citi's payout could be cut weighed on the shares on Dec. 27. Citi closed nearly 3.0% lower at $29.56, less than 25¢ away from a new 52-week low.
It's Been Expected
The dividend worries are nothing new. It's been nearly two months since equity analyst Meredith Whitney at CIBC World Markets pulled ahead of the Wall Street pack by saying Citi would have to cut its dividend and sell valuable assets to boost its ratio of tangible capital to assets, which she said had fallen to 2.8% by the end of October.
With the shares trading 27.3% below their closing price of $41.90 on Oct. 31, the date of Whitney's report, it's logical to assume a dividend cut, and a hefty one at that, has already been priced into the stock. If so, how much more selling could be in store once the dividend actually is cut?
A 40% cut would reduce the annual dividend to $1.30, reducing the yield from the current 7.3% to 4.3% based on the Dec. 27 closing price. Would that be so terrible?
After all, even if Citi were to cut its dividend by 50%, the yield would still be higher than JPMorgan Chase's (JPM) current dividend yield of 3.5%, says Jack Ablin, chief investment officer at Harris Private Bank in Chicago, which oversees $55 billion in assets.
Pressure on Common Dividend
On a Nov. 5 conference call, Citi said it had no plans to cut its dividend and assured analysts that it could restore its capital ratios by mid-2008, just on the strength of its business growth. The bank's targeted capital ratio level is 7.5% for Tier-1 capital and 6.5% for tangible common equity to risk-weighted managed assets. As of Sept. 30, it had a Tier-1 ratio of 7.3% and a TCE/RWMA ratio of 5.9%.
On Dec. 13, when it announced that it would bail out seven affiliated structured investment vehicles and bring $49 billion in assets onto its balance sheet, the bank reaffirmed the timeline for restoring its capital ratios but didn't reaffirm its intention to maintain the current common dividend payout level, Banc of America Securities said in a research note on Dec. 14.
BAS analyst John McDonald said that while he didn't expect the bank to cut its dividend so soon after the convertible offering to the Abu Dhabi Investment Authority in exchange for a $7.5 billion cash infusion, continued pressure on capital levels may cause the company to increasingly consider cutting its dividend as 2008 progresses. (BAS and its affiliates have co-managed an offering of securities for Citigroup and provided investment banking services for the company within the past 12 months)
Citi's obligation to pay an 11% dividend yield on the preferred shares it sold to the Abu Dhabi fund will make paying a common dividend that much more difficult, said Ablin at Harris Private Bank.
"Anyone thinking that Citi is going to continue to pay 7.3% on their common shares indefinitely drank a little too much eggnog" over the holiday, he said.
Bigger Worry on the Horizon
The worst of the market jitters concerning Citi might be over, but to Ablin, the real worry is what the bank could face once the subprime mortgage teaser rates start to reset. Most of the SIVs are guided by delinquency and default rates, not market valuation changes, he noted.
The most senior ranked tranches of the SIVs require that if delinquency and default rates exceed certain levels, other collateral must be liquidated to help support the credit-worthiness of the senior tranches, he said.
"So it could be that we're marking things down, trying to understand the market value, but if [assets] actually have to get liquidated, that could create a much bigger problem near-term," Ablin said.
The forced liquidation of billions of dollars of collateral into a market that has very little interest in buying it could result in a liquidity crisis and require that Citigroup buys the assets itself, he warned.
Despite the losses that financial stocks have absorbed over the past couple of months, no one will really know how much bad news has already been priced into them until earnings season is well under way, said Brian Gendreau, an investment strategist at ING Investment Management in New York.
Indeed, Citi shareholders may have bigger things to worry about than a lower dividend.