NAB’s recent positive earnings surprise and steady dividend should reassure ASX investors that the major banks are not about to significantly cut their dividends any time soon.
The market was only concerned about NAB’s dividend, with flat to slightly higher dividends forecast for the other big three.
But now that the worst fear about NAB has been shown to be unfounded, the market should relax about the whole sector’s dividends.
We believe the major banks do not need to, and will not, cut their dividends in the near term.
The current story of the banking sector is actually one of preparing for a slow-growth world in which regulatory demands pertaining to capital and funding remain stronger than they were before the GFC.
Major banks on the ASX already have world-leading capital strength with common equity tier 1 ratios in the top quartile of banks globally.
Our view is that the upcoming statement of the Basel Committee on Banking Supervision will be benign because the powerful European bank regulators on the committee are reluctant to saddle their banks with even more capital when European economies need more, not less, lending.
The response of Australia’s banking regulator, APRA, should also be moderate given that the world-class capital strength of Australia’s major banks arguably fulfils the requirement of the Financial System Inquiry that banks be “unquestionably strong”.
Any requirements for extra regulatory capital should be phased in gradually over coming years, with banks allowed to reach these via dividend reinvestment plans and varying the capital intensity of their lending mix. Business loans require more capital to be held against them, while home loans require less.
Bank lending grew by 5.4% over the year to September, down from 6.7% a year earlier, the implication being that banks do not need as much capital to back new loans.
In earlier times bank lending grew at twice the rate of nominal GDP; today the ratio is only one because services, the growth sector, require relatively little borrowing and investment to grow.
In last week’s profit result, NAB’s capital position was sufficiently strong for the board to step away from its earlier target dividend payout ratio of 70%-75%, which had been promoted as a hard figure.
This and recent payouts over 80% were the main reason many analysts expected a dividend cut.
NAB’s decision should give other banks the confidence to maintain their dividends given huge pressure on their boards from shareholders to do so, and the market now expects a more gradual path to NAB’s targeted lower payout ratio range.
The external environment for banks also does not suggest dividend cuts are likely.
Since the 1980s banks have cut dividends on only three occasions: after the 1987 crash, after the 1991 recession and during the GFC.
Each period was marked by extreme financial volatility and downwards pressure on bank earnings. Today’s banking environment is not delivering the banks much growth but it is relatively stable.
Our base case is modest improvement in the non-mining economy, a soft landing in the Sydney and Melbourne property markets and no spikes in unemployment or interest rates – the two ingredients for sharply higher bad debts.
Further, sharemarket pricing of bank stocks does not suggest dividend cuts.
The major banks trade on yields of 6%-7%, which is generous but not at the level of a stock about to significantly cut its dividend. For example, BHP shares traded on a double-digit historical yield before the dividend halved. In contrast, the banks’ 6%-7% dividend yields are at a level that only compensates investors for slow growth.
So in the absence of a major shock we believe banks can afford to hold their current dividends.
We see the path ahead now being clearer for the sector’s share prices to recover after the recent period of underperformance.