Feature Stories | Apr 08 2020
This story features AUSTRALIA & NEW ZEALAND BANKING GROUP, and other companies. For more info SHARE ANALYSIS: ANZ
Just when bank analysts were attempting to forecast the possible extent of dividend cuts for Australia's banks, along comes APRA to help make the banks' decisions for them.
-APRA directive changes the landscape for banks
-Dividends to be materially cut, deferred or suspended
-All hangs on the unknown extent of the crisis
By Greg Peel
"More worryingly, after a shocker of an FY19, is that FY20 is shaping up to be even worse."
This is an extract from Australian Banks: More Dividend Cuts To Come, published on November 29, 2019 (https://www.fnarena.com/index.php/2019/11/29/australian-banks-more-dividend-cuts-to-come/).
At the time, Australia's banks were still reeling from Royal Commission fallout, the US and China were locked in a trade war, the RBA was cutting rates in an attempt to avoid Australia falling into recession, and the bushfires underway since October were far from hitting their peak.
This was the banking sector outlook back then:
"It is widely assumed the RBA will cut again to 0.5%, if not next month at least February next year (which will be the next meeting). The governor has oft declared that there's no point in cutting below 0.5%, rather "unconventional measures" will be required, which implies QE of some nature.
If we're into unconventional measures, we will be staring down a recession. The government is finally starting to wake up to the problem, but most suggest it's a case of too little, too late on the fiscal stimulus front.
The outlook for loan demand and thus bank revenue growth in FY20 remains subdued. To that end, and given all of the issues heretofore outlined, analysts suggest FY20 will be all about the banks desperately trying to hang on to what dividends they are now paying. Analysts are largely agreed more dividend cuts are on the horizon."
We'll never know if Australia was destined to fall into recession, or whether, due to a complete lack of action on the part of the Morrison government, the RBA would have been forced to cut to 0.5% (or lower) and adopt unconventional measures. But what we do know is that 2019 was not a good starting point for the Australian economy when we entered 2020.
We'll never know if the banks would have been forced into cutting their dividends meet capital requirements, because now everything has changed.
The Long Arm of the Regulator
This article had been intended to outline bank analyst assumptions with regard Australian bank dividends going forward in this crisis. But the news flow is moving very fast at this time. A quick summary: all of them decided dividend cuts were likely, if not unavoidable.
The Reserve Bank of New Zealand put the cat among the pigeons last week when it suspended bank dividend payments. Citi's analysts, for one, were surprised, given the bulk of NZ banking services is provided by Australia's Big Four. Yet Citi concluded it was an easy decision for the RBNZ to make, enabling the central bank to build up a capital reserve in the event of the virus leading to an existential banking crisis.
Soon after, dividend suspensions were also announced for UK and European banks. In the US, the majors got together and agreed to all suspend share buybacks, but not dividends. US banks are much better capitalised than UK and European banks, and Morgan Stanley's CEO pointed out the moral dilemma of taking bank dividend income away from retirees already reeling from zero interest rates.
US banks may yet be forced to suspend dividends, but only if the crisis deteriorates markedly. (US bank dividend yield pales in comparison to Australian yields.)
Scott Morrison's immediate response was to state he had no intention of suspending Australian bank dividends. But then it's not his call to make. CEOs of the Big Four responded by suggesting they would not be suspending dividends at this stage, with Westpac's CEO also pointing out the same retiree income dilemma.
No suspension does not mean dividends may nevertheless need to be cut.
It's all academic now, as yesterday APRA advised Australian banks to "seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer".
The regulator expects that all discretionary capital distributions, particularly ordinary dividends, to be deferred or "materially reduced".
It's advice, not instruction, but it does make any decision a lot easier for the banks, given it is assumed they were preparing to at least cut their dividends anyway. If retirees now miss out on much-coveted bank dividend income, blame APRA.
The banks can still pay dividends if they want, they might choose to pay a much smaller dividend, they might defer their dividend payment to a later date, or they might suspend the next dividend altogether. Note that ANZ Bank ((ANZ)), National Bank ((NAB)), Westpac ((WBC)) and Bank of Queensland ((BOQ)) declare dividends in April-May, while Commonwealth Bank ((CBA)) and Bendigo & Adelaide Bank ((BEN)) declare in August.
Bank of Queensland was a sure bet to cut dividends at its result release, which coincidentally was this morning. The board has instead suspended dividends in line with APRA's advice. We might call that a "get out of jail free" card. Bank analysts are now assuming the majors will follow suit.
More on that in a minute. For now, the story so far, prior to APRA's bombshell.
Back in the Red
In 2008, life as we knew did not much change. Retirement dreams were shattered, job losses and business failures followed, but not to the extent as many feared. The majority of Australians continued to work, businesses remained open, schools remained full and toilet paper was in abundance.
The Global Financial Crisis was just that — a financial crisis. The threat of recession the Rudd government moved to avert with fiscal stimulus and the RBA supported with rate cuts proved overwrought. Labor supporters will tell you it was because of Rudd's actions a recession was averted, while Coalition supporters will tell you a lack of recession meant Rudd unnecessarily sent the country into budget deficit.
The GFC flowed out of the banks and into the economy. This crisis is flowing out of the economy and into the banks. In 2008 it was feared Australia would fall into recession. In 2020 there has never been any question.
Ahead of the GFC, Australia's, and the world's, banks were poorly capitalised and highly leveraged, which led to the rolling house of cards effect that began in 2007 in dodgy US mortgage derivatives and resulted downunder in desperate bank capital raisings in 2009.
It is not without a certain irony that while it took a decade before Australian regulators settled on just what level of capital banks should carry so as to be prepared for the next GFC, the fact they finally did means Australia's banks, and US banks, are now highly capitalised and leveraged within much tighter bounds.
The last recession in 1990-91 in technical terms of consecutive quarterly contractions but arguably 1990-94 in impact — was the result of a classic boom-bust cycle that did come out of the economy and flow into the banks. Unemployment and business failures soared, and Westpac ((WBC)) went very close to going under, but for white knight Kerry Packer.
The Royal Commission into banking still lingers as an issue for the banks, with ultimate remediation costs yet to be known, but for now, "brand damage" fallout is largely forgotten. Also forgotten is the sworn duty of every politician to be a bank-basher for popularity's sake.
When the RBA made its first virus-related "emergency" rate cut of -25 basis points to 0.50%, the prime minister instructed the banks to pass on all of that cut to mortgage rates. The banks meekly complied. But when the RBA later went "all in" cutting to the low boundary 0.25% and introducing QE-like measures — there was not a whisper out of the government when the banks took the opportunity not to pass on the cut in full, if at all. For by then Morrison needed the banks on side, and for that he needed them to survive.
Now, the banks are part of the "Team Australia" effort, as the analysts at Morgans put it, "to build a sturdy economic bridge to get across the abyss created by Covid-19". Morgans believes this will practically mean is all sorts of exceptions will be applied to all sorts of rules, and "certain parts of the Australian economy will be tried to be put on ice for a period of six months".
In the 1990s, the recession was largely left to play out as any boom-bust cycle should. The RBA continuously cut its cash rate, but started from 14%. Prior excesses were left to be punished without support, and ultimately the economy "was passed from weak hands to strong".
In the GFC, hard nut US capitalists expected the same process to be allowed to play out, but instead the government bailed out large companies and institutions, including the banks, and the Fed introduced QE. It was still not enough to avert what Americans call The Great Recession.
In Australia the government handed out cheques to households and the RBA continuously cut its cash rate. Starting at 7.25%. That time the Australian economy contracted for only one quarter.
This time, with recession inevitable under unique (to anyone alive at least) circumstances, Team Australia is hoping to put the astronauts into suspended animation as the spaceship passes dangerously close to the sun, before emerging singed but safe out the other side. The government, the RBA, APRA, ASIC and the corporate community are all in the Team.
And so are we.
The Pros and Cons
"We view the coordinated response from the Government, APRA and the RBA as favourable for the sector, which should cushion the near-term blow for the banks," says Macquarie. "Measures such as the relaxation of responsible lending standards, the government partially guaranteeing SME's liquidity facilities, temporary relief from "unquestionably strong" CET1 [capital] requirements, and delaying the recognition of deteriorating credit quality on capital are positives for banks".
Ostensibly what has happened on the regulator front, aside from government and RBA fiscal and monetary support, is APRA has said to the banks (before yesterday) "After the GFC scare we have got you into a capital and risk position that we believe will allow you to handle the next crisis. This is the next crisis. Go handle it. We've got your backs."
Solid bank capital positions heading into this crisis, as opposed to 1990 and 2008, are a major positive.
This has allowed the banks, with the support of other Team Australia members, to offer six month mortgage repayment holidays for both households and businesses. Interest will nonetheless continue to accrue and be tacked on to the end of the loan.
Morgans suspects the regulators will grant exceptions to the banks for an interim period such that hardship cases are not classified as conventional delinquencies, such cases do not result in material increases in bad debt provisions (tying up capital), and such cases do not result in material increases to "risk weighted assets", for which the banks otherwise have a regulated cap.
A significant negative is the fact the Australian economy was already on a downward slope last year and the RBA had already been cutting its cash rate to ever lower historically low levels heading into the crisis. Rate cuts started in 1990 from 14%, in 2008 from 7.25%, and in 2020 from 0.75%.
But the central bank has now moved to "unconventional measures", which by any other name implies in practice the unencumbered printing of money. The currency is not at any greater risk than the virus impact on the Australian (and Chinese) economies might imply, because to put it bluntly, everyone's doing it. Particularly the Fed.
And it's difficult to see inflation being a risk anytime soon.
How Long is a Piece of String?
The GFC provided us with the eventually hackneyed expressions of "don't try and catch a falling knife," in reference to a plunging stock market, "kicking the can down the road," in reference to government bailouts and monetary stimulus, and "pushing on a piece of string," in reference to any supporting action being able to avert recession.
This time around we might invoke the old question "how long is a piece of string?" for no one can be certain just how long the virus crisis might last. Peak-virus and a flattening of the curve in Australia and global hotspots may offer some light at the end of the tunnel, but the reality is we have little idea what's going on in "the third world", and to ease restrictions too early in the developed world is to risk a second wave.
From the outset the accepted, but not ensured, time frame has been six months. A lot hinges on whether this time frame can be held to.
The bottom line is the longer the country remains in lockdown, the greater the number of unemployed workers, bad debts and bankruptcies. This is, or at least was, the swing factor in bank analysts determinations of the potential of, and the extent of, bank dividend cuts, bearing in mind the banks were likely to cut, analysts assumed, even before the virus emerged.
Analysts had gone to a lot of effort to produce base case and bear case scenarios the two largely split on the possible longevity of the crisis using assumptions about peak unemployment levels and the impact on mortgage defaults, and peak business stress and the impact on loan defaults. These scenarios had informed dividend assumptions, and the consensus conclusion was that elevated dividend payout ratios would have to be reined in, amounting to dividend cuts.
But now it's a different situation. "We believe it is sensible for banks to preserve capital in the current environment," Macquarie analysts said in a note this morning, "but we expected the banks to make that decision".
APRA has encouraged the banks to draw on established "stress test" criteria in making their decisions. Macquarie suggests the banks may choose to reduce their dividends, but under a stressed scenario the capacity for the banks to pay a dividend diminishes to the extent they may need to raise capital.
Thus Macquarie believes they are likely choose suspension, with a caveat that dividends can be reinstated (and possibly even special dividends paid) once things return to normal.
Here we have to distinguish between "suspend" and "defer". Outside of the banking sector, many an Australian listed company has moved to suspend dividends due to uncertainty. These are effectively lost dividends, although some give-back might follow down the track. Other companies, and the number is fewer, have decided to defer payment of their dividend to a later date, assuming things actually do go back to normal at some point.
Morgans suggests that the response from bank boards may be to pay a dividend on a materially reduced payout, or defer any decision about a dividend to a later date, but neither are the broker's new base case. That assumes all the banks due to declare a dividend this or next month suspend their dividends, and that Commonwealth Bank does the same in August.
(Morgans does not cover Bendigo & Adelaide Bank.)
In the wake of APRA's directive, Ord Minnett has cut its dividend assumptions, rather than assume suspensions, by -50% for all the majors bar CBA, for which the broker forecasts -28% given a stronger capital position.
Morgan Stanley is in the same camp, making note that Australian retail shareholders own almost 50% of bank shares and thus suspension of dividends would be another source of pressure on household incomes. Rather than deferring dividends, the banks will likely make larger reductions than the -30%-plus to 2020-21 dividends the broker had forecast before the APRA announcement, and/or implement fully underwritten dividend reinvestment plans.
Note that every DRP offer taken up by an existing shareholder results in the creation of new capital.
Is there any good news?
Ahead of any dividend decision, the majors were holding capital in excess of minimum regulatory requirements. Were they to have pushed forward with their own dividend decisions, perhaps making cuts but not material cuts, the risk is that an extended virus crisis would inevitably result in the need to raise new capital, diluting shareholder dividends per share.
A move to suspend, defer or materially cut dividends would mean new raisings would not be necessary, in broker views.
That said, Fitch is the first rating agency to downgrade its Australian credit bank ratings, to A+ from AA-, which will result in a greater cost of wholesale funding for the banks, and more so if Moody's and/or Standard & Poor's follow suit.
But APRA has also said that in making dividend decisions, the regulator also expects boards will appropriately limit executive cash bonuses, mindful of the current challenging environment.
Every cloud, eh? They'll be stuck having to drink the domestic stuff.
Note: Typically in bank feature stories, FNArena publishes a table reflecting consensus broker ratings, targets and forecasts, including dividend growth and yield numbers. Given heightened uncertainty, rapidly shifting day to day developments, and the fact that not all FNArena database brokers have yet updated based on the APRA announcement, I have decided not to do so at this time as the data would simply be misleading.
Notwithstanding any fresh developments in the meantime, the next table will be published post the upcoming May bank reporting season.
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