It’s official — the era of big dividends from the banks is over. Not just fading naturally but expressly prohibited by the prudential regulator.
The unprecedented ruling from the Australian Prudential Regulation Authority this week that banks — which paid 80 per cent plus of profits out in dividends for the past five years — now must limit the payout ratio to no more than 50 per cent would pinch at any time.
In a period of falling profits it is going to pack a punch.
It’s a measure that will be toughest of all for long-term bank investors such as retirees.
They have watched bank share prices sink on the basis that these so-called bond proxies always pay a great income. But shareholders in Commonwealth Bank may be looking at a dividend yield of only 3.5 per cent this year.
We know from the row over franked dividends before the federal election last year that bank dividends have been the backbone of retail investor portfolios.
Until very recently the problems for bank stocks were within traditional parameters: the yield curve was making it hard to extract good margins, lending volumes were slow and residual problems identified in the royal commission remained an issue.
This year the problems moved into new territory; crucially, the mortgage deferrals loom now as a major threat. An estimated 10 per cent of the entire mortgage market is currently deferred.
Nonetheless, four out of five of the 500,000-plus borrowers deferring their loans say they are not in a position to start repayments.
This is the black spot in the banks — it’s the deferrals in the banking system that is the outstanding risk of this period.
Moreover, it is the essential reason the regulator has capped the dividend payouts.
If there is one positive from the new APRA rules, it is that banks are actually allowed to pay something. On August 12, CBA will be the first bank to report under the new rules.
The edict gives the bank an opportunity to galvanise its 830,000 shareholders after ANZ and Westpac did not pay dividends in the last half year and National Australia Bank did pay a dividend but raised capital at the same time.
The forecasts for second half dividend per share at CBA with several key analysts pencilling in around 50c — compared with $2 in the first half.
Banks v miners
On that basis CBA, now around $71.63, will pay a dividend yield of only 3.5 per cent, which just happens to be the forecast average yield for the whole market in the year ahead.
This year the big miners will pay one-third of all dividends on the Australian Securities Exchange; the banks will pay only one-fifth. What to do?
As Don Hamson, managing director of Plato Investment Management, suggests: “The first thing is that shareholders in banks are going to have to get used to it.”
Though there are fears that bank investors will lose the plot and rush into high-risk high yields offered by unlisted trusts, it is much likelier instead they will look around the ASX to where alternative dividend income might be found.
Industry surveys suggest most listed utilities and infrastructure companies, which already pay good dividends, will increase their payouts in the year ahead. The problem is that those shares are often very expensive while right now bank stocks are not.
Similarly, mining stocks are seen to be at the top of the cycle.
Though no analyst can forecast bank numbers with any confidence in this environment, they are paid to do just that — and they are beginning to see light at the end of the tunnel.
The average of bank dividend payout ratios just now is 35 per cent. The maximum under the new limit is 50 per cent.
Yet Brendan Sproules at Citi believes the restrictions will not be in place for long and, with the not-to-be-missed caveat, “in the absence of another credit quality shock” we can expect a 75 per cent dividend payout ratio back in place at the major banks within two years.
In turn, some are putting money on those assumptions.
According to veteran fund manager Paul Xiradis, chief executive at Ausbil Investment Management, we are “now the most overweight we have been in banks for a number of years”.
This is on the basis that we think earnings will exceed expectations, bad and doubtful debts may not be nearly as bad as the market has been pricing and, if that is the case, they have strong balance sheets and banks will return to paying an ongoing sustainable dividend, albeit at a lower payout ratio.