Dividend cuts loom at big banks as bushfires add to woes: Morgan Stanley

Dividend cuts are in sight at the big four banks, say analysts who also warn of the impact of rising disaster costs.

Australia’s bushfires will impose a range of pressures on the big banks. Picture: AAP

Insurance claims, loan losses for local businesses and elevated mortgage arrears are just some of the financial costs the banks will bear from the bushfires.

But it is the second-order effects, such as lower retail spending and potential rate cuts, that pose the bigger risk and will have a greater impact on earnings, according to brokerage Morgan Stanley.

Tighter lending standards, meanwhile, will limit the rebound in housing loan growth and major banks will continue to lose market share, they predict putting dividends of the lenders under pressure.

“We believe that the downside risks from the bushfires' second-order effects add to existing operating headwinds. We expect the banks to remain in an earnings per share downgrade cycle in the first half of 2020,” they added.

The near-term disruption in retail sales and the prospect of further rate cuts add to the banks’ earnings risk at a time when they are operating in an uncertain regulatory environment with a subdued outlook, with Morgan Stanley seeing risks of further dividend cuts and de-ratings.

Westpac on Monday said customers whose homes have been destroyed in the months-long catastrophic bushfire season will have their mortgages paid for an entire year as part of the bank’s efforts to assist communities affected by the crisis. Other major banks have also activated customer assistance packages to help with the recovery.

Morgan Stanley said the direct financial cost of the bushfires for banks will include: insurance claims; pledged contributions to bushfire recovery; cost of additional customer services in impacted areas; higher modelled provisions due to deferral of interest and loan repayments for impacted customers; and small to mid-sized business loan losses for local businesses in impacted areas.

Ratings agency S&P, meanwhile, also believes the bushfires will lead to greater loan arrears in the coming months. The risk of inadequate insurance for properties affected could increase loss-severity risk for loans in residential mortgage backed securities transactions, they warned.

"Arrears are likely to remain elevated for some time in areas already affected by drought conditions, particularly where agriculture forms a large share of local employment," said S&P Global Ratings credit analyst Erin Kitson.

Credit agency Moody’s said the lending losses were likely to be more contained. Around 6.7 per cent of residential mortgage-backed bonds Moody’s tracks are in fire-affected areas.

“But the actual share of loans that will be negatively affected by the fires – either because the underlying properties have been damaged or destroyed or because of the economic disruption caused by the disaster – is likely to be much smaller,” Moody’s analyst Alena Chen said.

“Recent natural disasters have all had limited and temporary impact on the performance of our (residential mortgage backed securities) portfolio,” she said.

Morgan Stanley has a “negative stance” on the big four lenders due in part to the challenging operating outlook, the growing threat of disruption, and their stretched trading multiples.

Downward pressure on margins is accelerating due to front book competition, rate cuts and the flat yield curve, the analysts said.

“We forecast major banks’ margins to fall by around 6 per cent in the 2020 financial year, but see downside risks to our forecasts,” they told clients. Bank margins fell by 8 basis points in 2019.

Mortgage growth, meanwhile, will average at around 1.5 per cent in the current financial year, down from 6 per cent in 2017. Morgan Stanley expects it to pick up slightly to around 4 per cent by 2021.

On the outlook for dividends, the analysts warn that banks will need to change their capital management approach given regulatory proposals and the pressure on their profitability.

“This means they should target higher capital levels and lower payout ratios,” they said.

The average payout ratio will be higher than 80 per cent if they hold their dividends steady.

Morgan Stanley is equal weight Westpac and ANZ and underweight Commonwealth Bank and National Australia Bank. The brokerage believes the direct financial cost of the bushfires will hit the majors’ 2020 financial year earnings by around 1 or 2 per cent.