Merrill May Cut Dividend for First Time, Options Traders Say

By Bradley Keoun and Jeff Kearns
Enlarge Image/Details

Aug. 14 (Bloomberg) -- Merrill Lynch & Co. Chief Executive Officer John Thain, battered by $19 billion of losses, vowed last week to maintain the firm's 35-cent quarterly dividend. The options market doesn't believe him.

``The market is pricing in a significant cut, roughly 50 percent or more,'' said Steve Sosnick, who trades options at Interactive Brokers Group Inc. in Greenwich, Connecticut, which handles a seventh of global equity options trading.

A reduction would be Merrill's first since it went public in 1971 and represent another reversal for Thain, 53, who told analysts he had plenty of capital two weeks before last month's record $9.8 billion stock offering. The sale lifted the burden of quarterly payouts by boosting shares outstanding by half.

The company has paid 35 cents a share since the first quarter of 2007, when Merrill's board raised it from 25 cents. The board reaffirmed the payment on July 30. Yet a reduction to 18 cents for the fourth quarter is reflected in the market, Bloomberg data show. The data compare prices for different Merrill options and apply formulas commonly used by traders to reflect the probability and timing of dividend payments.

Merrill, the third-biggest U.S. securities firm by market value, has the highest dividend yield among peers, at 5.5 percent. The yield moves inversely to the stock price, which has tumbled 52 percent this year to $25.60. Jessica Oppenheim, a Merrill spokeswoman, declined to comment.

Goldman, Morgan Stanley

Goldman Sachs Group Inc., the biggest U.S. securities firm, pays a 0.9 percent dividend yield, while No. 2 Morgan Stanley pays 2.7 percent and No. 4 Lehman pays 4.4 percent.

Sanford Bernstein & Co. analystBrad Hintz estimated in an Aug. 6 report that Merrill should cut its dividend by 64 percent to about 13 cents, to free up $1.5 billion of capital a year. Fox-Pitt Kelton analyst David Trone said in an Aug. 12 report that Merrill may face more than $5 billion of writedowns in the second half of 2008 and may need the extra capital as a buffer.

Thain, who took over as CEO in December after the ouster of Stan O'Neal, said in an Aug. 4 interview with CNBC that he didn't plan to cut the dividend, in part because many Merrill employees own the stock. His board doesn't need to declare a change in the fourth-quarter dividend until October.

``We believe we will shortly be back to profitability and be able to earn the dividend,'' Thain said. ``I prefer to get the yield lower by getting the stock price higher.''

Citigroup, Wachovia

Thain wouldn't be alone in failing to honor a dividend pledge. Citigroup Inc. cut its dividend 41 percent last November, two months after Chief Financial Officer Gary Crittenden said the bank was ``fully committed'' to keeping it steady. In January, Wachovia Corp. CEO Kennedy Thompson said he ``didn't need'' to reduce the payments, only to lose his job as his bank slashed the dividend more than 90 percent.

Merrill has ``a credibility problem,'' said Peter Sorrentino, who helps manage $16.5 billion, including 318,000 Merrill shares, at Huntington Asset Management in Cincinnati. ``If they announce tomorrow they cut the dividend it wouldn't surprise me.''

The options market predicted Citigroup's January cut, said Sveinn Palsson, a derivatives strategist at Credit Suisse Group in New York. Palsson himself published a report predicting a reduction two months before it happened.

``The options market has proven to be a good indicator of upcoming dividend changes,'' Palsson said. His analysis shows Merrill may cut the dividend to as little as 15 cents a share.

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net.