UBS: More rate cuts will cut bank dividends

Via InvestorDaily.

UBS reported that it was cautious on the Australian big four banks as the low rates environment made it harder for the banks to generate a lending spread and challenged the return on equity.

“If the housing market does not bounce back quickly, this could put material pressure on the banks’ earnings prospects over the medium term, implying that the dividend yields investors are relying upon come into question once again,” said the report.

Recent regulatory actions had also not helped the outlook, with the recent confirmation by APRA that it was going ahead with its proposal to reduce related party exposure limits to 25 per cent, in a move already impacting one bank’s capital abilities.

ANZ announced shortly after the confirmation that it would have limited capacity to inject fresh capital into NZ as its NZ subsidiary would be at or around the revised limit.

The $500 million operation risk change for ANZ, NAB and WBC would lead to a 16-18 bps reduction in CET1, with Westpac revealing in its third quarter report that it was running thin on capital, with UBS reducing it’s CET1 forecast in the bank to just 0.49 per cent, below APRA’s unquestionably strong minimum.

Of the major banks, UBS estimated that Commonwealth Bank was the in the best capital position, followed by ANZ, but both NAB and Westpac were in trouble.

Part of the capital position of CBA and ANZ was due to asset sales that would boost sales; however, UBS did note that these divestments had not yet been completed and there was uncertainty around its settlement.

UBS said many of these behaviours were due to APRA’s interpretation of the Murray report that said the regulator should set capital standards that kept institutions unquestionably strong.

“This recommendation, which was subsequently accepted by the government, was interpreted by APRA to mean that the major banks’ level 1 CET1 ratios are at least 10.5 per cent.

“However, we believe that if the Australian banks (level 1) hold substantial positions in their New Zealand subsidiaries, which are treated as a 400 per cent risk weight rather than a capital deduction, then double-gearing of capital brings this ‘unquestionably strong’ mandate set by the FSI into question.”

UBS said a simpler test was needed to ensure banks did not become overly reliant on capital repositioning strategies, which effectively double-counted capital in Australia and New Zealand.

Until this was done, UBS predicted that banks would continue to cut dividends and that investors would see through various strategies to ensure double-gearing did not occur.

“We expect CBA and WBC to join ANZ and NAB in cutting dividends should rates continue to fall.”

I can hear the aged scream already.

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  1. Once we are in solidly negative rates with continually rising asset prices the banks will have to shift to an Islamic finance model and take an equity position when they invent their thin air credit. All those negative rate bonds the gov. will force down the bank’s throats make it harder to dig yourself out of trouble as well.

    Maybe the markets are ahead of the economists this time and are pricing in an era of de-growth due to climate change being forced on us by the laws of nature.

  2. Low/negative rates are going to challenge all sorts of businesses: insurance companies, pension funds, banks.

    We are closer to a reset than many imagine. There are High Yield bonds in Europe trading with negative yields. The clock is well and truly ticking: if the current trend continues it will destroy a host of businesses key to the economy and if yields enter a bear market, it’s game over in general.

    • Even StevenMEMBER

      I’m not convinced it will be that challenging for most, Dominic. most financial institutions (superfunds, insurers, banks) are required to match their assets with their liabilities. If yields go down and their liabilities go up, they should see an offsetting rise in their assets.

      The challenge will be for any institutions that haven’t matched.

      It seems to me the world is gradually adjusting to a low (or modestly negative) yield state. If yields go heavily negative we should start seeing some interesting effects (e.g. physical hoarding of cash).

      • ES
        The asset gains are a one off only. When these institutions roll their bond holdings they are going to roll into negatively yielding paper i.e. absolutely guaranteed to make a loss for the holder. Think about that: pension funds forced to invest in assets that will guarantee a loss for retirees. Same for insurance companies — enjoy your low premiums now because they won’t last in the face of negative yields. Ditto bank capital — banks are required by regulations to hold a certain proportion of their capital in ‘risk-free’ bonds i.e. sovereign paper. In other words, not only will bank profitability become seriously challenged (see earlier article on MB) but their capital base will come under constant attack from natural erosion i.e. negative yields. Say goodbye to those dividends 😉

        The point is this: businesses thrive when they’re growing and when they’re growing they are building a capital base which then helps them to grow further. In the presence of negative yields they’ll either be going ahead extremely slowly or going backwards. What idiot would invest a cent of their money in such a business. Negative yields will not last for the simple reason that they’ll eventually take down the entire economy. We have a reset coming soon.

    • Not necessarily. It is a perverse situation where even though dividends may be cut the dividend yield would still be a lot higher than deposit rates.

    • Good luck with this.
      If rates go to zero it is possible CBA is bid up to $100 as people chase yield.
      That will all come crashing down, but it would blow shorters out of the water.

    • Shorting Aus Banks way too risky. Stay away.

      – big dividends to pay out
      – government support up the wazoo
      – in the GFC the UK banned shorting banks to shore up stability… reckon they can’t do the same here?

      Nah. Short something expendable, like YBR.

      Not advice fckn.