Australia | Apr 24 2019
Brokers weigh up a subdued outlook for major banks ahead of interim reports in early May. Dividend reductions are considered highly probable, particularly at National Australia Bank.
-Rising credit losses should be monitored, Citi advises
-Trading income and banking fees likely to remain under pressure
-Modest dividend reductions could be forthcoming, particularly at NAB
By Eva Brocklehurst
Yields on banking stocks are in the sights of brokers, as interim results reporting nears and another major bank discloses further remediation costs. National Australia Bank ((NAB)) has advised it will review its dividend at the first half result, after reporting remediation-related charges of $525m after-tax for the first half. Of the charges, around 91% relate to the wealth business.
Credit Suisse believes the sector is exposed to earnings downgrades, amid lower asset growth and continued margin pressure. Moreover, asset quality will provide little in the way of protection from the headwinds.
JPMorgan expects the results to be messy, because of significant remediation costs, while net interest margins should reflect ongoing competition for mortgages. National Australia Bank is expected to show the best cash profit growth while ANZ Bank is likely to lag.
Benign asset quality trends are expected and capital positions remain solid, as major banks all should be above the 10.5% CET1 ratio. Still, the broker suspects further capital management plans are likely to be tempered by the proposed capital rules outlined by the Reserve Bank of New Zealand.
Concerns were raised about the stance of the RBNZ and its proposed new capital rules, but these concerns have now softened as has the potential for adverse capital or a dividend event, Citi suggests.
Credit Suisse expects ANZ Bank to provide a disappointing first half result, with a subdued balance sheet and continued margin pressure. The banks are expected to improve their expense verification while mortgage re-pricing should allow net interest margins to recover, although this may be competed away or affected by mix and switching.
Meanwhile, trading income and banking fees are likely to remain under pressure. Alarm bells will ring for the broker if there is any weakness in the upcoming first half reports in terms of mortgages and the automotive, small-medium enterprise (SME) and consumer segments.
For Macquarie Group, Credit Suisse believes it will be about maiden guidance for FY20 from the new CEO. A conservative statement is considered the likely starting point and key to this will be the proportion of performance fees from recent transactions that appear in FY19 or FY20.
Dividend forecasts are starting to diverge and Citi notes an increasing propensity to cuts to dividend forecasts in outer years on the basis of tight capital positions, remediation costs and potential macro concerns across the sector.
Yet the broker assumes dividends remain flat. Citi notes National Australia Bank faced a similar dilemma when its dividend pay-out ratios were in excess of 90% at times in 2014, 2015 and also 2018. The bank chose to hold the dividend steady and look through the one-off items.
However, in the midst of a leadership transition, the board may take a different approach this time, the broker acknowledges. Major banks have, historically, only cut their dividends during times of credit stress. This occurred in the early 1990s, 2009 and 2016 in the case of ANZ Bank, driven by deteriorating asset quality.
Only in a broad-based economic downturn or recession would dividends be expected to be cut dramatically. The broker calculates that a credit loss scenario where losses peaked at 60 basis points (2008/09 peaked at 80bps) would result in reductions to Commonwealth Bank's dividend of -30% and the remaining three major banks around -15%.
More significantly, a credit stress event would affect ANZ Bank and Commonwealth Bank ((CBA)) to a lesser extent than National Australia Bank and Westpac, and Citi's current order of preference in the banks would reverse in favour of the former two if that was the case.
UBS expects all banks to maintain their dividends, given pressure to release franking credits before a potential change in government. Still, reductions are not completely discounted because of the NZ environment, remediation costs and asset quality.
Morgans takes the recent statement from National Australia Bank – that the dividend will be reviewed at the first half – to mean that it will be cut. While the bank is sticking with first half guidance for expenses growth to be broadly flat, Morgans expects it will underperform the other majors on costs over the next two years. This is because the transformation strategy and productivity savings target laid out by the former CEO Andrew Thorburn have been jeopardised by his departure.
Ord Minnett is increasingly confident National Australia Bank will cut its first half dividend to $0.90 a share, down 9c, yet notes it is still trading on a healthy 7% dividend yield. Credit Suisse and JPMorgan agree with a cut to $0.90 per share for the half year, returning pay-out to a more sustainable level around 82%. JPMorgan expects a flat dividend of $0.94 per share for Westpac, representing a pay-out ratio of 95%.
Yet Citi believes investors are unnecessarily concerned about the high pay-out ratios. The emergence of small dividend adjustments because of high remediation and regulatory costs does not explain the underperformance in the sector versus other yield sectors.
Citi asserts a relatively benign environment for asset quality and credit losses remains key. If there is a meaningful step up in credit losses then the outlook may change, but until dividends are reduced significantly, and capital is called on, the banking sector will remain defensive and offer relative outperformance.
See also Bank Woes Unlikely To Abate Soon on April 5, 2019.
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