How sustainable are my bank dividends?

Market insights

Patrick Hodgens, Portfolio Manager Macquarie Investment Management
Monday 22 August 2016

The dilemma of the big four Australian banks

Over the past 25 years, investors in the big four Australian banks would have been incredibly happy. Strong share price performance and growing dividends have rewarded investors.

With such strong performance behind us the big question is “where to from here?” Will the tailwinds of the last 25 years continue? Or will tailwinds become headwinds, making earnings and dividend growth harder find in the future?


What were once tailwinds are now becoming headwinds…

The banks strong share price outperformance and ability to provide ever increasing dividends has historically been driven by above market earnings growth and return on equity (ROE). However, as we explain below, the tailwinds of yesterday may be transforming into the headwinds of tomorrow.

Asset Growth is beginning to slow

Bank housing loan books have increased five-fold in the last 25 years. But the growth of the past is already visibly slowing. Consumer credit growth is likely be more difficult going forward with housing affordability becoming more challenged and ongoing changes to the regulatory environment making investment property less attractive.

All this means asset growth is likely to be significantly slower over the foreseeable future.

Competition is intensifying

Each of the big four is fighting to win new business and retain existing business. However, it’s a battle they are struggling to win. There is strong competition for new home owners, new loans and new investment loans.

All this competition is leading to lower margins.

Bad Debts cannot get any lower!

Bad debts are lower than they have been in the last 25 years. To put this into perspective, National Australian Bank reported 6 bps of bad debts in second half 2015, that’s $600 lost for every $1m lent. Looking forward we expect bad debts to rise back towards system trend which would result in a 2% headwind to bank earnings.

Bad debts have to rise – maybe only slowly but rise they will.


What does this mean for earnings?

Historically, banks have experienced consistently stronger earnings growth than the rest of the market (ex-resources) at 5.5% average vs. the market at just under 3%. We expect earnings growth to fall to 4% in FY17 and under 3% in FY18. In contrast, our analysts believe expectations for growth in the industrials sector are expected to be up 8% and 7% respectively.


How sustainable are my bank’s dividends?

The big four Australian banks have historically benefited from being able to grow earnings above market but also fall back on increasing payout ratios in periods of weak earnings growth.

Over the past decade bank payout ratios have drifted from 60% up to 70% and even 80% in some instances. We don’t believe such levels are sustainable. In fact, we expect the big four to slowly reduce their payout ratios to a more sustainable range of between 60% and 75% over the next 3-5 years.

Chart 1. Bank payout ratios

Australian Equity Dividend Yield versus Bond Yield

Source: Company data


Summary

Slowing asset growth, increasing competition and rising bad debts are all headwinds that are likely to result in lower earnings growth for the big four banks over the next few years.
Combining the outlook of lower growth with payout ratios at already unsustainably high levels the big four banks have a limited number of levers they can pull to maintain the growth in dividends that investors have become accustomed to. While not predicting large cuts in absolute dividends, we expect investors will experience flat dividends for a few years, as the banks trying to grow into more sustainable payout ratios.

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