Diminished dividend dilemma for Commonwealth Bank

A lower dividend and a wave of mortgage deferrals leaves the bank’s army of retail shareholders in a tight spot. Picture: AFP

Income seeking investors now have a conundrum when it comes to Commonwealth Bank. They are looking at a very strong financial institution in an appalling market where the outlook presents real risks to an already reduced dividend stream.

As stockbrokers UBS have put it, “the yield is not particularly attractive given the risk profile”.

There’s the rub.

For a dividend yield of around 4 per cent you are buying a bank where all the key numbers are going the wrong way.

Profits are falling, costs are rising and margins are shrinking.

You can get a 4 per cent dividend yield in other places — including the big listed miners that are actually enjoying upgrades just now on the back of a second wind for iron ore prices.

Moreover, even when paying a total dividend at $2.98, which is 30 per cent lower than last year, Commonwealth Bank is up against its maximum allowable payout under new prudential regulations.

In terms of funding, the bank has probably never been so well fortified, with a stunning 74 per cent of its funding from deposits.

However, it has serious issues on the books that run from the conventional to the unprecedented.

Credit quality is deteriorating; loan impairment expenses (representing loans that won’t be paid back) have more than doubled to $2.5bn in 12 months.

Compliance costs that relate back to failures revealed at the royal commission are rising too.

But the elephant in the room is the potential black hole of mortgage deferrals: no Australian bank has a road map for this challenge.

These deferrals are 8 per cent of the mortgage book and 15 per cent of the business book.

What’s more, we have got a first-time glimpse of the level of investment mortgages deferred — they represent 28 per cent of all deferred home loans.

The pace of deferrals may be slowing, but three out of four borrowers that have deferred are still not paying a cent.

And keep in mind the timeframe for these deferrals has recently been pushed further out into the year.

If the income investor’s conundrum is whether the bank’s diminished dividend is worth the risk, the bank’s own conundrum is that if it moves hard on these deferring customers it risks setting off a downward spiral in the property market.

As the nation’s biggest lender that would be shooting itself in the foot.

There are 890,000 investors in CBA and if they were asked today “would they pay $74 a share under these circumstances?” you wonder how many might sign up.

In reality many of these investors got their holdings by way of privatisation or bought them as a long-term “bond-like” investment that would pay good franked dividends in perpetuity.

In pushing the dividend to the maximum in the hope that the retail army will stay on board, CEO Matt Comyn is following the playbook created by his chairman Catherine Livingstone when she chaired Telstra post GFC.

The natural inertia of Telstra’s dividend hungry retail base carried the telco through that period. CBA will be hoping to repeat that story in the months ahead.