The declaration of first quarter earnings is over. Like everybody else I was interested in updates from our banks. I was expecting another round huge loses and write downs, and downsizing. Fortunately or unfortunately, depending upon whether you believe the results, that was not the case. Most of the major banks showed profitability. I have reserved this argument for later. I was intrigued by the comments coming out of the banking CEOs. The CEOs of all major banks, viz., Bank of America, Citigroup, JP Morgan, Goldman Sachs, Well Fargo, BB&T (and may be more) have criticized governments heavy handedness and continued interference in the way these esteemed folks run their banks. This criticism was directed particularly at TARP program in which these banks took money from.

When government instituted the TARP program, these same bank CEOs were happy to take liquid capital to shore up their balance sheet. These CEOs were happy to take practically zero interest money from government. At that point in time, when panic set in (if we can call it?):

• they could not make realistic projection to figure out what could happen;
• they could not understand what is the state of their on balance sheet;
• they could not understand that whether they really needed TARP money;
• they could not figure out that there is no free lunch; and
• they could not figure out that any large investors will need something in return (even if that investor is a government and not opportunistic private shark)?

What do you do with those millions that you get paid for, for indecisiveness? At that point in time, not a single CEO came out to proclaim they do not need TARP funding. Their house is in proper order. They kept quiet (were asked to keep quiet?).

Now when the largest investor (in this case government) is tightening screws, asking for accountability, and gunning for their heads, they are feeling uncomfortable. They are feeling this is way too much interference. In addition, many financial media pundits have claimed this will result in politicizing the lending from banks to common people. They cite Freddie and Fannie. Weren’t these banks lending freely until 2007, before the government came in with free money for you guys?

Banking CEOs now are coming out saying they want to return TARP money. Well, if you didn’t need it at first place, where is that money now? You should be able to give them back immediately? Why do you have to wait for government? Why do you need to go raise equity funding or capital issues in the private markets?

If these CEOs believe their house is in order, and they do not foresee any capital liquidity issue in near future, why they are not just returning TARP money back?

I am not a fan of government running our private corporations. It continuously runs our national budget in red, so they definitely do not have credentials to run profit center enterprises. They should limit their job to policy making and regulatory process. However, in this particular case, I would like to think government’s TARP funding like a shark investor. This shark gave these banking CEOs huge amount of liquid capital when they wanted. So what’s wrong in government asking for accountability (albeit the execution can be question, but keeping that aside).

Somebody needs to ask questions to these CEOs and hold them accountable. They should not be allowed to keep changing their colors as per economic season. There ain’t any fall season’s in economy or banking operations. This is not adapting. This is camouflaging.

Two of my fellow bloggers (D4L and DGI) on The DIV-Net have presented their perspective on how to deal with a given company stocks when it decides to cut of freeze the common shareholder dividends. You can read their viewpoints at these links (D4L at Article1, DGI at Article1, Article2, and Article3). Both the bloggers have presented very compelling arguments supported by relevant data set. It would be hard to argue with their observations and conclusions. Here I am discussing my approach on how I dealt with dividend cuts and freeze in my portfolio.

Since year 2005 in my dividend growth portfolio, I had owned BAC, WFC, C, WL, and GE. I will not use GE in this discussion because I am focusing on financial sector. By early 2007 I had reached my limit (10% maximum) of asset allocation in terms of my actual capital allocated. Prior to peak during Oct 2007, my financial sector allocation became in excess of 14%. This was due to the increase in value. Even though I became over allocated in financial sector, I did not take any action. And that was a mistake. I should have used re-balancing (or stopped automatic dividend re-investment in same stock).

My primary reason for investing in these stocks was dividend growth (and secondary being value). Now year 2008 brought dividend cuts in all four financial stocks viz. BAC, WFC, C, and WL. The value of the share price started to plunge and I started to incur paper loses. I had to taken action of reducing my risk and cut my losses.

This is where I believe individuals need to look at their strategy from their own perspective, measure it against their own objectives, measure it against their own portfolio risk profile, and then take action.

I reduced my portfolio risk by selling C and WL when dividend cuts were announced. I took a very small loss on C, and 5.3% total loss on WL. For both of these stocks, I did not see them satisfying my buying objective of dividend growth and value. In addition, both of these companies did not seem to have any strong market positioning to given me confidence of their survival. I continue to hold BAC and WFC. There are few reasons.

(1) My overall portfolio allocation in these individual companies had become very small, well below my max limit of 3% in each company. This was driven by reduction in market value. In addition, my allocation to financial sector was well below my max limit of 10%. Therefore, even if I continue to hold these stocks, I would be comfortable from the viewpoint of my allocation and personal risk profile.

(2) At this point in time, I continue to believe that eight to ten years down the line these two companies will still survive. These two still have value in the sense that they have significant market presence in the financial industry.

(3) I did some re-allocation in my capital. I moved WFC and BAC in my value/opportunity portfolio. In terms of number of shares, I doubled my position in BAC at price of $4.19. Similarly, in terms of number of shares, I increased my stake in WFC by 40% at a price of $11.13. After increasing my stake, the share price for both stocks continued to slide. The biggest concern was possibility of nationalization of BAC. For few days, I thought it was a big mistake. However, at this point in time, the combined positions for both of my stocks are very close to even value. Now time will tell, if this was a mistake or not.

The purpose of this discussion is not to present a counter argument to viewpoint of my fellow bloggers. I presented a differing viewpoint which calls for prudent strategy based on individuals risk profile and how they have structured their portfolios. I sold some and bought some. I know selling was a right decision. Time will tell whether buying was right decision or not.

In one of my earlier posts, I had discussed how smaller ones gets ignored, or gets buried under the media onslaughts, or perhaps they do not have the oomph! Dividend cuts by financial institutions (BAC, C, WFC, etc.) and corporations that supposedly represent American economy (GE, GM, PFE, etc) have been in headlines. In fact business media have been so focused on them that speculations with various scenarios start well before the announcement of dividend suspensions or reductions. In addition, business media has also given a wide coverage to Standard and Poor’s projection that cumulative dividends from corporations in S&P500 index will reduce by 13.3% for year 2009. In this environment it is likely for individual investors to get distracted and flustered by the dividend cuts. However, before we do that, let us look at current dividend situation in historical perspective.

The attached graphic (published in Business Week Magazine) shows a summary of number of corporations that have increased, decreased, or suspended their dividends. Since March 2008 to February 2009, the number of corporations increasing dividends has been consistently higher by significant number. Except August 2008, every month more than 10 corporations have increased their dividends. In February 2009, approximately 30 corporations have raised their dividends.

Now if we look at the cumulative results from March 2008 to February 2009, then out of the 500 corporations in the index:

• 205 corporations have increased their dividends;
• 63 have decreased their dividends; and
• 25 have suspended their dividends.

Historically, after 1989, any new entrant to dividend aristocrat list stayed for an average of 6.5 years (source). What this means is on an average the dividend aristocrat will reduce or suspend dividends after 31.5 years (i.e. 25 years to become aristocrat + 6.5 years after listing). In addition, in the 15 year period starting from 1989, there have been approximately 120 corporations that have come and gone through this list. If not from 1989 then from 1992 onwards we have been in a secular bull market. Even during the secular bull market there were dividend aristocrats who were suspending or reducing dividends. The aristocrat list itself continued to churn during the 15 year long bull market.

We can see that there is nothing new or out of ordinary about dividends suspensions when we put the current trailing twelve months data (i.e. number of dividend decreases or suspensions) in context of last 20 years. Dividend suspension or reductions are natural part of any economic cycle (bull, bear, growth, recessions, etc.)

The graphic also shows that there is increasing trend in number of corporations that decreasing or suspending their dividends. However, there are still 205 corporations that are increasing their dividends. While I would agree that all 205 corporations may not have good quality of dividends, but then do we individual investors really need 205 corporations to invest?

Just because few well know corporations suspended their dividends, it does not mean every other corporation is doing the same. Dividend growth is still alive, healthy, and it continues to prosper. American economy still consists for many corporations that can sustain themselves without TARPing and TARARing. It’s a natural characteristic of business media to ignore the smaller non glamourous ones.