Will Bank of America 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 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.

What do you think?  Let me know!