Should Citi Cut Its Dividend?

by: Felix Salmon May 28, 2008 | about stocks: C    
Felix Salmon

Felix Salmon

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Holman Jenkins has a most peculiar column today which seemingly tries to defend Citigroup's decision to continue paying dividends, even as it's raising billions of dollars of capital elsewhere. Except he never quite comes out and says that Citi is doing the right thing: The best that he can come up with is that it's possible that Citi is doing the right thing. And even getting there is something of a stretch.

Holman has two main premises. Both are true, as far as they go, but neither does a particularly good job of getting him to where he wants to go.

1) Money is money. Whether banks are wiser to replenish their depleted capital by retaining income now used to pay dividends, or wiser to raise the capital from outside and keep paying the dividend, depends on which is a cheaper source of capital.
2) Money is money. Whether a company retains its earnings or pays them out, shareholders are still the beneficiaries of its cash, and shareholders are not so dumb they can't figure this out. They are not so dumb, in other words, as to prefer receiving a dividend if it would be more advantageous for their company to deploy its cash elsewhere.

If I were starting from these two premises, it wouldn't take me very long to come to the conclusion that continuing to pay out dividends was not a very clever idea. From the first, I could compare the largely metaphysical costs of simply retaining earnings, on the one hand, against the very real and very large costs of borrowing capital from major institutional investors, on the other. Unless those metaphysical costs of cutting the dividend were obviously huge - and they're not - then it would seem to be the cheaper, and therefore better, option.

From the second premise, I would deduce that shareholders will have voted on the present strategy every minute of the trading day. I would look at the results of that vote - shares trading at less than half their level this time last year - and conclude that they're not very happy with the dilution strategy at all.

So how does Jenkins decide otherwise? He first makes an irrelevant point:

Remember, Abu Dhabi, Singapore, Kuwait and various muckety-mucks just put more than $44 billion into Citi on terms that lock them in, while normal shareholders can come and go as they please.

Shareholders come and go by selling stock to each other, not by withdrawing any capital from Citigroup. If Citi decided to retain earnings rather than borrow money from muckety-mucks, then those retained earnings would be just as "locked in" as anything from other sources.

Jenkins follows this up by an argument which betrays his WSJ editorial page roots:

For years, Citi's shareholders have been concerned about a porky cost structure compared to its peers. A dividend is a form of discipline, imposing on management a need to be careful about costs so as not to be seen cannibalizing the company's long-term value to pay the dividend.

This is known in political economy circles as the "starve the beast" argument. It's used to justify tax cuts, on the grounds that if the government gets less revenue, it'll be forced to get more serious about cutting spending. So far, it's never worked.

And so we get to the point at which Jenkins ties everything up:

The company (so far) has had no trouble raising new capital - its offerings have even been oversubscribed - but another dividend cut might damage this appeal. It might instead be seen as management throwing in the towel on rationalizing Citi's costs and simply using Citi's cash flow to entrench itself. In which case, cutting the dividend could prove a very costly means of raising capital indeed.

I'm a little bit unclear as to what the word "itself" in this passage is referring to. Is it referring to Citigroup, the entity? If so, then Citigroup entrenching itself by means of its own cash flow would seem to be a jolly good idea to me, isn't that what businesses are meant to do?

On the other hand, if the "itself" refers rather to Citigroup's management entrenching itself using Citigroup's cashflow, then the clear implication here is that shareholders are unhappy with the present management. They might be unhappy because they don't like the current dividend policy - a possibility which seems not to have occurred to Jenkins. Or they might be unhappy because they think that the present crew, led by Vikram Pandit, just isn't very able when it comes to managing a company of 374,000 employees. Either way, cutting the dividend is unlikely to make the shareholders even more ill-disposed towards management than they already are.

I think that Jenkins's argument, insofar as there is one, boils down to "if Citi cut the dividend, then the share price might fall". Which would be a much more powerful argument if it weren't for the fact that the share price has been falling quite steadily anyway. Just maybe, if Citi cut the dividend, then the share price might rise. Stranger things have happened.

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This article has 13 comments:

  •  
    May 28 12:33 PM
    I imagine the author of this article has never struggled for a dime in his life. I'll give you a very good reason why Citi should not cut it's dividend -- I, like many other very small investors, own some shares of this company and, like me, the small amount of dividend paid to me helps a lot, especially lately. And there are a lot more little guys like me out there compared with the Abu Dhabi's of the world. Even if they don't need the money, we do. Citi, if you are listening, please don't cut that dividend.
    Reply | Link to Comment
  •  
    May 28 12:46 PM
    Wishful thinking. For the big banks dividends are the only thing investors have to hang on to. Recent events show that analysts don't seem to know. Neither do the managements.
    Without dividends why would one want to hold financial stocks?
    Reply | Link to Comment
  •  
    May 28 01:12 PM
    Regardless of the hard number facts of the issue, C's payment of dividends has an important psychological function, because the average troubled investor, who has in most cases already experienced a significant loss, at least feels that he is getting something while he waits for a rebound. In addition, since C suggested, both before and after the previous cut, that they weren't going to, a second cut would only be interpreted, rightly or wrongly, as a further sign of desperation. I.E.- Don't do it!!
    Reply | Link to Comment
  •  
    May 28 01:21 PM
    The other falacy in the "cut dividend" argument is revealed when you extrapolate it to every company that needs to raise capital. For example, TransCanada Pipeline (TRP) just did a multibillion dollar equity issue, but you don't hear anyone arguing that it should cut its dividend so as to reduce the amount of equity it has to raise.

    From a classical finance theory point of view the value of a stock should depend only on the NPV of future earnings and not whether or not it pays a dividend. However, from an emotional investing point of view, what a stable and growing dividend represents is a clear signal to shareholders that management is confident of future earnings. Cutting the dividend sends the opposite signal.
    Reply | Link to Comment
  •  
    May 28 01:21 PM
    Commercial banks are supposed to be "safe" stocks - suitable for widows and orphans - because of the heavy regulation they are supposed to face. Few, if any, long term investors in bank stocks expect more than just keeping up with the broader market, including paying decent dividends. It seems that managements of banks, as well as analysts, do not understand the needs of long term investors.
    Reply | Link to Comment
  •  
    May 28 01:49 PM
    The main reason that Exec's are loathe to cut the dividend is obvious, their options are related to the share price. Therefore if you cut the dividend, and the share value drops, their options are worth less. If they raise outside capital, they hope to avoid this consequence.

    I think that this is another example of Exec's working in their own best interests, rather than the Company's.

    A Bank having to lend money, or recapitalize, gives the impression that the Bank cannot use its depositors money as effectively as other institutions.
    Reply | Link to Comment
  •  
    May 28 05:51 PM
    Chrism - it's in the company's best interest to have a high share price! Mgmt is liable to the board which is liable to shareholders who want a high stock price.

    Anyway Citi's stock price would definitely bleed some serious red if they cut their dividend... it would be a signal that they are dying regardless of finance theory about dividend policy irrelevance. This would make any capital raising in the future much much more difficult. Dilution is the only answer at this point unfortunately.
    Reply | Link to Comment
  •  
    May 28 10:04 PM
    Felix..catch a clue!! I can't believe a money sucking equity that has more derivative skeletons in their closet than we can imagine would even be paying a dividend!?! Perhaps Citi would gain some cred if they came clean..those that own Citi should really have a sit down with their better half...
    Reply | Link to Comment
  •  
    May 28 10:44 PM
    Uhh... apparently a couple of you haven't been following Meredith Whitney. Let C pay the divvy all the way down to the basement. It really doesn't matter. Oversubscribed? let's see 'em put out another issue. They can't. C is on the govt. dole along with it's peers and you people believe the dividend is a big issue for them? WAKE UP SHEEPLE!
    Reply | Link to Comment
  •  
    May 29 09:50 AM
    ecklebob....did you ever hear of Elaine Garzarelli....if not you're too young to understand that like the stock market analysts have their good runs and their lousey runs........and that also applies to Ms. Whitney who has every right to make her calls....what's appalling is all the lemmings who are willing to follow her blindly because she made 1 (ONE) really good and prescient call.
    Signed: Chump for Citi
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  •  
    May 29 11:51 AM
    Garzarelli was a brief star for Shearson Lehman Brothers back in the 80's.
    Citigroup has already cut its dividend, and I for one don't want a complete elimination.
    Reply | Link to Comment
  •  
    May 29 12:17 PM
    Am I the only one whos blood pressure boils,any time "Citi" is given press, making analyst stock recommendations!
    Reply | Link to Comment
  •  
    May 29 06:43 PM
    I might just have to buy more of this... the more Meredith Whitney and her followers bash Citi, the more I like Citi. I just hate cocky ladies.
    Reply | Link to Comment
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