Can banks maintain dividends in a slowdown?

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Citi asks the question today: How will bank dividends hold up during the Australian rebalancing? Their answer is positive.

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From our base case – which forecasts the sector delivering EPS growth of ~ 4% in FY14/FY15 — Our base case over the next two years assumes i) an economy in transition from the resource capex boom, ii) continued low credit growth and household deleveraging, iii) improved funding conditions, iv) modest dividend rises and some capital buybacks, though the latter mainly at CBA. Going in to this year we had expected B&DD expenses to continue to improve, though the interim results were a positive surprise to even our generally optimistic forecasts.

We model a generalized slowdown to test the resilience of earnings, dividends and capital — To test the resilience of our present capital and dividend estimates, we have modeled a “1 in 6 year” economic slowdown event, which we assume would come from transmission of a regional wide slowdown. We assume the economy narrowly avoids a recession in late 2014, with little, if any, discretionary fiscal stimulus, and the RBA cutting the cash rate a further 100/125 bps.

EPS impacts are modest, no absolute DPS cuts — Our slowdown scenario generates modest impacts on our current FY15E EPS: a 10% fall at WBC up to 15% at ANZ, as we assume Asian loan growth also falls considerably in any Asian region wide slowdown. EPS falls 3-8% below FY13E levels. We assume none of the major banks would increase dividends in such a slowdown (not knowing how hard/long the slowdown would be) and DRP neutralization would cease for two years. Despite high initial payout ratios – we expect 86% in FY13E at WBC based on “cash “ earnings – no bank would be forced to cut dividends in this slowdown event, though NAB would come closest. This reflects the much higher capital ratios banks now have, and the much lower leverage in corporate Australia than we saw in past “near to recession” slowdowns.

Overall CBA fares best and NAB the worst in our capital modeling through the slowdown scenario — Reflecting its higher ROE and better credit quality, CBA would build CET1 ~90 bps in this scenario, and, as in previous slowdowns, would be very well placed to make timely acquisitions, should such opportunities arise. By contrast, NAB’s CET1 ratio falls ~20 bps through the scenario, due to its high initial payout ratio, lower ROE, and lower initial asset quality. At the individual banks these results are consistent with (in terms of impacts at the individual banks), but by no means as severe as our last year’s stress testing of a 1 in 30 year economic crunch (see Australian Banks – Stress Testing Bank Dividends: ANZ and CBA Get a Pass Mark).

Dividend sustainability supports compelling yields — With no threat to dividend payouts from our slowdown scenario, the sector’s 5.9% (8.3% pre tax) prospective dividend yield still, in our view, provides compelling value. With the bank sector now 10% off its recent May highs, prospective yields still maintain a 200bps premium to 10 year bonds, and a 200bps premium to term deposit rates (both ~450bps pre-tax). We retain our Buy ratings on CBA, WBC and ANZ.

Fair enough. But it gives some idea of what happens if we don’t narrowly avoid a recession in 2014, or 2015, or 2016, as mining investment drains away…

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.