Bank of America Shares Plunge on Earnings Shortfall, Major Dividend Cut

By , Money Morning •

From Staff Reports
Money Morning

Shares of Bank of American Corp. (BAC) fell more than 26% during trading yesterday (Tuesday) as investors reacted to the company’s disclosure that it was cutting its dividend after its third-quarter earnings plunged a stunning 68%.

The Charlotte-based BofA also said it will cut its dividend in half – to 32 cents a share – and will sell as much as $10 billion in common stock to beef up its balance sheet.

The dividend cut underscores the crisis-like capital situation in the U.S. banking sector, especially since Bank of America executives had repeatedly told Wall Street that the bank would not cut the dividend, and had sufficient capital in place to maintain the 64-cent-a-share quarterly payout.

But at its current stock price, an annual dividend payout of $2.56 a share equates to an unrealistic – and unsustainable – dividend yield of more than 10%.

Bank of America detailed its deteriorating earnings outlook and plans for a dividend cut after the close of trading Monday. The Charlotte-based BofA actually moved its earnings announcement up so it could release the report early.

Bank of America shares fell $8.45 each to close at  $23.77 yesterday. The shares have traded between $18.44 and $52.96 over the past 52 weeks.

"It appears that Bank of America moved up its release date in order to beat Wells Fargo [& Co. (WFC)] or Citigroup [Inc. (C)] to the marketplace and possibly to raise the capital before the short-sale rules are lifted," Keefe, Bruyette & Woods Inc. analysts wrote in a research report today.

The Securities and Exchange Commission has effectively banned the short sales of several hundred different financial stocks, although that temporary rule is scheduled to expire this week. With a short sale, speculators borrow shares of a stock and then sell them, betting they can buy the stock back later at a lower price, and pocket the difference.

For the third quarter, BofA said it earned $1.18 billion, or 15 cents a share, a 68% decline from the $3.70 billion, or 82 cents a share, in the same period a year ago. Analysts polled by FactSet Research had expected earnings of 61 cents a share, MarketWatch.com reported.

Bank of America Chairman and Chief Executive Kenneth D. Lewis blamed escalating charges for soured credit market investments and higher credit-card charge-offs for the results.

In a prepared statement, Lewis said that “these are the most difficult times for financial institutions that I have experienced in my 39 years in banking." Then, during a subsequent conference call with analysts, Lewis said that “we’ve seen – even in the last 45 days – things worsen.”

That prompted the company to take "a view that the recession is going to be a little deeper than we thought," Lewis said.

BofA said the dividend reduction should save about $1.4 billion a quarter – capital the bank needs to maintain its strength.

Deutsche Bank AG (DB) analyst Michael Mayo told MarketWatch that “while showing more realism with plans to raise $10 billion of new common stock [and announcing plans to] cut the dividend in half, Bank of America suffers as the largest U.S. consumer bank at a time of greater consumer weakness.”

Mayo maintained a “Hold” rating on the shares, but cut his 2009 full year profit estimate from the previous level of $3 a share to a new profit projection of $2.50 a share. He also cut his target price for BofA shares from $28 a share to a new target of $26 a share.

Money Morning Contributing Editor Horacio Marquez penned his most recent “Buy, Sell or Hold” column on Bank of America, noting that its recent maneuvers have made it an intriguing buying opportunity – for investors with an ultra-long-term profit horizon.

On July 1, BofA snapped up the operations of dying mortgage leader Countrywide Financial Corp. Bank of America ended up paying only about $2.5 billion in Bank of America stock in a deal that had been announced back on Jan. 11. BofA had already invested $2 billion for a 16% stake in Countrywide.

Then came the weekend switcheroo. In a stunning turn of events back on Sept. 15, when investors were watching and waiting for Lehman Brothers Holdings Inc.’s (OTC: LEHMQ) possible acquisition by either Bank of America or Barclays PLC (ADR: BCS), BofA instead emerged from the weekend announcing that it had struck a deal with Merrill Lynch & Co. Inc.’s (MER) President and CEO John A. Thain. 

Realizing that the credit crisis had rendered moot the concept of the standalone investment bank, Thain avoided Lehman’s ultimate fate – bankruptcy – agreeing to be bought out by Bank of America. BofA’s Lewis astutely took full advantage of the opportunity.

He got to acquire Merrill Lynch in an all-stock transaction for a 70% premium over a very depressed Merrill Lynch stock price at about 1.83 times tangible book value, or about $50 billion, less than a third of its own market capitalization.  What’s more, when the transaction closes (probably in the first quarter of 2009), Bank of America will jump from $1.7 trillion in assets to about $2.7 trillion in assets, retaining a strong capitalization ratio.

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