The slowing economy and the credit crunch are claiming another victim: dividend payments. That's especially the case for battered financial...

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The slowing economy and the credit crunch are claiming another victim: dividend payments.

That’s especially the case for battered financial stocks, which make up the bulk of the dividend-paying companies and have been making headlines lately with massive reductions in their payouts to shareholders. Meanwhile, even if other companies aren’t cutting dividends, far fewer are raising them.

“Times are tough and that makes CEOs less willing to spend on a lot of things — including dividends,” says Kevin Toney, a portfolio manager on the American Century Equity Income Fund.

Citigroup slashed its dividend 41 percent in January. In recent weeks, Seattle-based Washington Mutual cut its quarterly payout to a penny from 15 cents a share, Wachovia cut its dividend 41 percent and CIT Group sliced its payout 60 percent.

Though financial companies’ dividends, because of their import and the size of the cuts, are garnering the most attention, nonfinancial companies are quietly becoming stingier with their payouts.

Standard & Poor’s calculates that in the first quarter, 6.2 percent of nonfinancial companies cut their dividend compared with 3.4 percent of financials.

The number of companies increasing dividends across the entire stock universe dropped 19 percent in the first quarter from the year-ago period, and the number of companies cutting dividends is at its highest since 1991, according to S&P.

In the market for stock options, where dividends can play an important role in determining prices, the outlook for dividends is glum. Historically, dividends on companies in the S&P 500 index have risen 6 percent a year. Options traders don’t think that kind of increase is in the cards.

“The options market is pricing in very little or no growth in [dividends] for the next two years and about 2 percent growth after that,” says Christopher Hauck, a director in the equity-derivatives strategy group at Deutsche Bank.

But if there’s any good news among the bad, expectations for additional big dividend cuts are beginning to fade.

On April 18, the options market abruptly reversed course on expectations for another big cut in Citigroup’s dividend. Earlier in that week, Citi’s options were trading at prices that implied the bank would cut its dividend to 17.5 cents a share from 32 cents, according to Credit Suisse Group. But after Citi’s earnings report April 18, which wasn’t as bad as some had feared, options trading was implying a 27-cent dividend.

For financials, “the sentiment is that the worst is over,” says Sveinn Palsson, equity-derivatives strategist at Credit Suisse.

The dividend reductions thus far come against the backdrop of a falloff in corporate earnings as the economy has weakened. Earnings in the first quarter are on track to post their third consecutive quarterly decline.

On the plus side for the dividend outlook, Palsson says that, in general, corporate balance sheets are pretty healthy. But he adds that “if the economy keeps shrinking and earnings go down, it’s unlikely that this is going to be a year where companies will increase dividends.” And, he says, “A lot of the growth companies that are doing very well right now aren’t really paying dividends.”

The current situation interrupts a rebound in the popularity of dividends after a long slump. In 2001, the percentage of companies in the S&P 500 paying a dividend hit a record low of 70.2 percent, down from 93.8 percent in 1980, according to S&P.

By the end of last year, partly in response to a change in the tax laws that made getting paid in dividends more attractive to investors, that percentage had risen to 78 percent.

For investors, this was accompanied by a rebound in the dividend yield on S&P 500 stocks, which is a measure of the annual dividend relative to their share price. In 1980, the dividend yield stood at 4.54 percent, but 20 years later it had dropped to just above 1 percent.

By the end of 2007, the dividend yield on the S&P 500 was back up to 1.9 percent. It was at 2.17 percent on March 31, although that was largely a reflection of the drop in stock prices this year.

American Century’s Toney says that in addition to shoring up balance sheets, there are other reasons companies are conserving cash. Some, he says, may find it better use of cash to buy back their own stock now that share prices have fallen. Others may see the current troubled economic environment as creating acquisition opportunities.

And, Toney says, there’s uncertainty about the more favorable tax treatment that was given certain kinds of stock dividends in 2003. With the coming presidential election, some executives worry that the tax rate on qualified dividends could be raised from its current level of 15 percent.

The outlook for dividends isn’t completely bleak, however. Credit Suisse’s Palsson says that among the components of the Dow industrials, the options market two weeks ago was implying dividend increases for companies such as IBM and Hewlett Packard. In addition, “within the energy sector, further increases are expected — not surprisingly, as the sector is booming,” Palsson says.