With the major crisis in the credit market, investors must brace themselves for the first major casualty of squeezed credit: dividend payments. The loan defaults from the housing meltdown create a catalyst across financial markets, impacting the entire economy’s performance – and your portfolio income.
Sub-prime mortgage woes weigh down on financial markets
Since the second half of 2007, the downward pressure on credit markets from mortgage defaults by home buyers has reached a boiling point. Sub-prime mortgages have been hit tremendously hard, with estimated defaults reaching approximately $100 billion.
In addition, the delinquency rate for mortgages, cars, and other consumer loans have increased more than 2.27% in the third quarter of 2007. This is the highest delinquency and late payment rate since 2001’s second quarter, when the US economy was undergoing a recession set forth by the dot com bust.
Implications for your portfolio
How do the major defaults in the mortgage industries impact your portfolio? Rising defaults of loans implies losses for financial institutions, strain on earnings, less availability of cash, and reduced investments by investors in bonds and debt markets. Thus, businesses and financiers alike will need to not only conserve cash, but also raise further capital.
However, since companies will be limited in their ability to raise additional funds from the sale of bonds and debt-backed loans, both banks and financial companies have begun slashing their dividends.
The disappearance of dividends in 2008
Citigroup (CITI) and Washington Mutual (WM) are the first two major financial firms to reduce dividends. For Washington Mutual, its dividend cut by $.15 has pushed down the company’s share price by $.25 thus far.
As the woes of defaulting loans continue, more banks are likely to cut dividends. If the credit markets continue to fall and the US economy weakens, other areas of the economy, such as the consumer sector, are also feeling the crunch of falling credit. The dismal holiday season, which has been the weakest since the recession-bound 2002, has already begun to take its toll on the consumer industries. Thus, expect companies to begin cutting their dividend rates across many industries.
According to Standard & Poors, there were more companies that slashed or suspended dividends in 2007 than companies that increased their dividends. Indeed, industry analysts are predicting that investors should anticipate seeing dividends disappear in 2008 – especially in financial service industries.
Micro and macro-dividends
The importance of dividends can hardy be underestimated, both in the microeconomic and macroeconomic sense. Dividends are important not only for the maintenance of share prices and as a major source of income for many investors, but also for the overall health of the economy. Dividend payouts provide one of the most important barometers of the overall health of the economy.
If financial institutions are facing liquidity problems, they will not be able to meet the credit needs of the market. Subsequently, the overall economy may further fall, putting additional pressures on earnings, dividends, and share prices.
Falling dividends have an immediate impact on share prices, as has been seen in respects to Washington Mutual. If such cases were isolated and transitory, that could provide an excellent opportunity to investors to buy shares at very low prices. However, the present scenario does not seem to be confined or short-term. Falling dividends will be a continuing phenomenon in 2008 and the symptom of a wider economic malaise.
Plan to Prepare Your Portfolio
Investors need to brace themselves not only for a considerable reduction in dividend income and share prices, but also in overall investments. If the US economy weakens further, it might be appropriate to conserve cash or think globally, investing in emerging markets.