Australian banks run risk of retiree mutiny with dividend cuts

Banks are slashing dividends the world over and investors aren’t exactly thrilled about it anywhere. But nowhere is the tension between bank prudence and investor expectation as extreme as it is in Australia.

The Australian market has always paid a much higher dividend yield than any other developed market – about 4.5% historically for the S&P/ASX200 index, compared with 2.5% for global equities – and traditionally the big four banks have been the foundation of that arrangement. It has been absolutely routine for many years to get between 5% and 8% yield from the banks.

On top of that, Australian tax law allows for dividend imputation, meaning that investors typically get a tax credit because the company is paying dividends out of post-tax income and therefore tax has already been paid.

Consequently, Australians tend to express dividends in two ways: the outright dividend and the grossed-up figure, allowing for the value of that tax credit. In high-tax Australia, the grossed-up result can touch double digit returns.

It’s a great situation for the investor, and many retail investors, particularly retirees, build their entire investment approach around it. There are thousands of Australians whose retirements are funded by the steady and reliable income that comes from bank stock dividends.

That makes it a particularly tricky time when banks decide to stop paying them. For many investors, big dividends are a lifeline, a duty, an inalienable right.

In recent weeks, three of the big four Australian banks have reported their half-year results for fiscal 2020 – Commonwealth Bank is the odd one out – with each of them, unsurprisingly, announcing dramatic drops in cash profits and increases in provisions.

Australia has, in health terms, sailed through Covid-19 just as it did in financial terms through the global financial crisis. But despite the comparatively low death count, its economy has still been torpedoed by lockdown, particularly for small businesses.

Two of the big four, Westpac and ANZ, both decided to defer their interim dividends. They’re not outright cancelled; Westpac says it will review its dividend options through the year, while ANZ says it will give an update on its thinking in August.

This was not a huge surprise. In April, the Australian Prudential Regulation Authority (Apra), always one of the world’s more proactive financial regulators, had warned all deposit-taking institutions to “limit discretionary capital distributions in the months ahead” and to make sure they had sufficient buffers and capacity to keep lending.

It specifically suggested “prudent reductions in dividends, taking into account the uncertain outlook for the operating environment and the need to preserve capacity to prioritize these critical activities.”

However, the banks were careful to say they hadn’t forgotten their investors.

“We recognize many shareholders rely on our dividends as a source of income and fully recognize the impact these decisions have,” Westpac chief executive Peter King said at his bank’s half-year announcement. “However, we must remain prudent at this point in time.”

His CFO, Gary Thursby, added: “At this stage, we just don’t know how severe or long this crisis will be.”

ANZ chairman David Gonski also referred to the fact that half a million of the bank’s shareholders relied on the income from its dividends, but put its own decision back onto Apra, saying: “The board agrees with the regulator’s guidance that deferring a decision on the 2020 interim dividend is prudent.”

Shayne Elliott, CEO of ANZ

ANZ chief executive Shayne Elliott had a snappy line for it: “Our response has been designed to flatten the curve of financial failure.”

While this was disappointing for retail investors, it wasn’t much of a surprise. Odder, in that context, was what NAB did – pay a dividend and announce a capital raising at exactly the same time.

The interim dividend, at 30 cents a share, down by two thirds on the previous year, was accompanied by a A$3.5 billion ($2.27 billion) raising, which on first glance looks counterintuitive. If you need that much capital, why are you also giving it out?

The answer was those retail investors and retirees. They make up 48% of NAB’s share register.

Ross McEwan, NAB’s chief executive, said he and the board had considered cutting dividends to zero, but “we don’t want them running out the door at the same time we are doing a capital raise.”

There’s probably nowhere else in the world where this equation would have made sense.

Fund managers are trying to make sense of it all. It’s a big call to get right.

Paul Xiradis, chief investment officer of Ausbil Investment Management, says that over the last decade, the total return for the S&P/ASX200 was 7.1%, of which 6.1% – or 87% of the total return – came from dividends and distributions. Half of all those dividends are paid by just eight companies, including the big four banks.

“Dividends are important for investors who require the income stream they offer,” he says.

During the financial crisis, dividends fell 30% in value over the 2008/09 financial year (Australian tax and investment years end on June 30).

“We are expecting a similar impact this time around,” says Xiradis, although he expects it to be temporary.

Nobody is expecting Australian banks to go under. Their balance sheets were in good shape right through the financial crisis and are even better now. But Xiradis encourages investors to try to put aside their short-term love of distributions and think of the bigger picture.

“While investors do not like to see dividends trimmed, we are seeing banks hold back some of their dividends and in some instances raising capital to further strengthen their balance sheets and provisions,” he says. “Ultimately, this is a good thing for earnings stability and growth.”

Ross McEwan, NAB’s chief executive

The availability of reliable dividends has largely allowed Australians to duck a problem that vexes investors everywhere else in the world – the lack of options for reliable yield.

Now, they have to reassess their steady approach. Holding ANZ and not much caring about the share price because of the dividend was a perfectly good strategy for most investors over the last 10 years – until it suddenly wasn’t.

“High income is generally more risky and ‘sustainable growth’ looks less so at the moment, if you think in terms of total return,” says Jamie Nemtsas, director at financial advisory firm Wattle Partners.

“You might be looking at a regional building company in New South Wales that has got a strong dividend on paper, but it’s going to be far better to hold something like Google that has got a massive audience, low cost of capital, great balance sheet – and you’re sacrificing some kind of regular income for a very, very strong company.”

All this is going to matter mightily to banks if the staid and predictable investors who make up as much as half of their share registers start to divest because they can’t rely on a dividend and don’t see much growth potential in the shares themselves.

And why would they? It’s been widely acknowledged for years that the glory days are over in Australian banking; and they were still trying to recover from the reputational shocks of the Royal Commission on banking behaviour before anyone had heard of Covid-19.

That explains NAB’s otherwise illogical move: try to keep retail onside even when it’s clear you can’t afford to do so. Retail investors need bank dividend yield; banks need the stability of that loyal and patient investor base.

Macquarie is in a slightly different position to the big four banks, being much less of a deposit-taker and lender, and more of an asset manager and investment bank. It maintained a dividend in its own full-year results, albeit down 50% year on year.

On the results call, Euromoney asked CFO Alex Harvey to explain the bank’s thinking on deciding upon the dividend – and the degree to which retail expectations of yield factored into their decision.

“Retail investors are an important part of our share registry, and as a rule they do like to receive dividends – but so do a whole lot of institutional shareholders as well,” he said. “That is an important part of the shareholder landscape in Australia… That’s the history, and we like to continue to do that. But this year of course is a very unusual set of circumstances.”

Regulators have asked the banks to focus on preservation of capital so that they can continue to be active and support their clients over the next year or so, he says.

Macquarie has done a lot of analysis of its balance sheet, stress-testing its capital and liquidity, and has modelled “future economic circumstances on some very adverse bases to ensure we do have sufficient capital to be able to pay a dividend,” it says.

There are also hopes Commonwealth Bank of Australia (CBA) will be able to maintain a dividend. Given its different accounting year, it doesn’t need to make a decision on that until August. Its third-quarter trading guidance on Wednesday May 13 contained no guidance on the full-year dividend.

In an odd moment of prescience, Westpac now looks very good for having raised $2.8 billion in December, although it did so after it was discovered that the bank had been a conduit for some particularly nasty money-laundering enterprises.

Meanwhile, life goes on in the various other aspects of Australian banking, such as the sale of wealth management subsidiaries in the wake of the Hayne Commission.

In May, Commonwealth Bank of Australia confirmed it was selling a 55% stake in its wealth subsidiary, Colonial First State, to KKR in a transaction valuing the business at A$3.3 billion and bringing in cash proceeds of A$1.7 billion.

CBA sold its global asset management businesses to Mitsubishi UFJ Trust and Banking Corporation for A$4.13 billion in August 2019 and sold its life insurance arm, CommInsure, to AIA Group for A$3.8 billion a year earlier, a deal that also included its New Zealand life insurance business, Sovereign.