Next up for banks: dividend cuts

There’s been a nice little bank short squeeze running this week. How far it has to run is anybody’s guess:

But the MB Fund is selling into it because we retain the view that the bank bear market has far yet to run as profits are squeezed by:

• rising funding costs;
• criminal remediation;
• post-RC lending processes overhauls;
• lower system growth as lending standards tighten, and
• rising bad debts as house prices fall and the commodity income shock returns.

All of that leads us to conclude that it is only a matter of time before the bank’s big bribe – dividends – will have to be cut.

Jonathon Mott as UBS explores this question regarding NAB:

1H18 Cash NPAT $2,759m (down 17%), EPS 99cps, Div 99cps, ROE 11%

The NAB result was subdued, with the underlying revenue trends soft and deteriorating. This appears to have caught NAB by surprise. 1H18 Result Highlights (sequential): (1) Revenue rose just 0.7%. Net Interest Income fell slightly, with loans up just 1%, offset by a 1bp reduction in NIM to 187bp. Non-Interest Income bounced mainly due to trading; (2) Costs rose 23% as guided, as NAB undertook restructuring; (3) Pre-Provision Profits fell 16%; (4) Credit charges 13bp; (5) Asset quality was strong, but may have peaked. 90dpd rose 3bp to 43bp driven by deterioration in the Australian mortgage book, watchlist loans rose 14bp to 121bp.

Revenue outlook is deteriorating but NAB is sticking with the program

Despite the weakening revenue environment, NAB appears undeterred. It still intends to invest $1.5bn on its ‘Accelerate’ program, leading to 5-8% cost growth in FY18 (plus $755m in restructuring spend) then flat costs in FY19/20. However, with sector revenue growth slowing sharply – a trend which we expect to continue – NAB is likely to emerge with a cost base set too high for the environment. Much of NAB’s investment appears ‘catch-up spend’. However, we were still surprised NAB would not entertain the idea of working harder on its costs despite numerous questions at today’s briefing.

Financial returns are under pressure – can the dividend hold?

We have downgraded EPS by 1%/3%/4% given: (1) slower credit growth; (2) slightly weaker NIM; (3) partly offset by a slight reduction in credit charges (we assume credit charges reach just 21bp by FY20) and no discount on the DRP. However, this leads to a falling EPS profile. We forecast EPS of $2.15 in FY20E, 10% lower than in FY17. This makes holding the $1.98 dividend very challenging even in a subdued RWA growth environment. As a result, any deterioration in credit quality will likely lead to a dividend cut given the very elevated payout ratio and pro-cyclicality in RWA. (Note: the proposed demerger/IPO of MLC should reduce EPS by ~9cps and is not yet in our forecasts. Unless the dividend is adjusted we estimate the FY20 payout ratio would rise to ~96%).

Valuation: Maintain Sell. PT $27.50 (GGM Based + Franking)

We remain cautious on NAB. Following downgrades it is now trading on 13.4x FY19E and 1.6x book for 12% ROE. Its 6.7% dividend yield appears under threat.

That’s a very low BDD number going forward and the divi is still in trouble…