Yield story still intact for the banks

We believe major bank dividends are sustainable. This is despite a challenging operating environment that we feel is being reasonably managed to grow profitably at a steady rate and lower overall earnings volatility. In this report, we look at historical precedents to make our case.

Recent steps taken have included strengthening the balance sheet, focusing on the more profitable retail and business banking lines, offsetting higher funding costs through lending rate rises (as always, unofficially implementing monetary policy on behalf of the RBA!), further reducing the cost base and taking actions to remediate issues raised by the banking inquiry.

This optimism is also based on the understanding that loan impairment expenses (LIE) – being the key driver behind banks’ significant dividend intentions – should not increase to levels experienced in past crises due to de-risking efforts to date [i.e. away from unsecured personal lending (193bp GLA) and real estate construction (114bp GLA), and towards mortgages (3bp GLA)] and expectations of a stable economy.

To put this into perspective, bank sector dividends have gone backwards only on three occasions in the last 39 years and these followed: (1) the 1987 crash (15% reduction, BDD charges exceeded 50bp); (2) the early-1990s recession (35% reduction, BDD charges increased to 267%); and (3) the GFC (23% reduction, BDD charges reached 42bp).

The reasons were largely due to poor assessment of commercial lending risks and unique economic events such as external liquidity shocks and a combination of high inflation and high interest and unemployment rates. This is unlike today’s economic setting and more conservative lending practices. The banks have also improved their capital, funding and liquidity positions since the GFC and these should further enhance the sustainability of their dividends. Finally, major bank dividends remain highly attractive relative to term deposit and cash account rates (on average by as much as 6.5% and 8.0% respectively).

Our preferred major banks are WBC (lower earnings volatility, conservative credit risk management and strong overall balance sheet – P/T $31.20, Buy) and ANZ (strong capital management flexibility to either expand lending volumes or return surplus capital to shareholders via share buybacks – P/T $31.60, Buy). Our summary table follows, and you can access the report in full below that.