The financial regulator has ordered the big banks to cut their dividends in response to the COVID-19 crisis – dealing a major blow to the incomes of investors and super fund members.
Banks and financial companies, which account for 26.9 per cent of the local sharemarket’s value, have proven popular stocks in recent years as they have delivered after-tax yields as high as 8 per cent at a time when term deposit rates have fallen below 1 per cent.
But investors will have to accept much lower returns this year, as the financial regulator APRA has ordered them to restrict their dividend payments to 50 per cent of their earnings.
Although it is more confident than it was in April that the banks will survive the crisis, APRA is still urging banks to play it safe.
“It is important that banks manage their capital capacity prudently, moderating dividend payments to sustainable levels and prioritising lending to support households and businesses during the economic recovery,” APRA said in a letter to lenders on Wednesday.
It also wants banks to encourage shareholders to participate in dividend reinvestment plans to build up the banks’ capital base, rather than taking out cash via dividends.
Given that the banks usually pay up to 90 per cent of their earnings in dividends, APRA’s move will deliver a big blow to the incomes of investors and super fund members.
So far this year, ANZ and Westpac have delayed dividend payments altogether while NAB paid out only 30 cents per share in its May interim dividend, compared to 83 cents for the same time in 2019.
All will be caught
Commonwealth and Macquarie shareholders got normal interim payments because their organisations have an earlier balance date, which meant dividends were paid before the pandemic.
But for the rest of the calendar year, all banks will have to restrict their dividends to 50 per cent of earnings.
The banks have been popular because of their high returns and earnings growth since the GFC, but APRA has just changed that reality.
Just how badly the dividend cuts will affect investors and super fund members will depend on their exposure to the banks.
Self-managed super funds will be the hardest hit in the retirement space, because they are typically more exposed.As this chart from December 2017 (the most recent available) shows, SMSFs typically hold about 60 per cent of their assets in Australian shares and often have high exposures to banks in that allocation.
“We see people come in here wanting advice on their SMSFs in which the big four banks make up 50 to 60 per cent of the portfolio,” said Michael Abrahamsson, a financial planner with Flinders Private Wealth.
“If that’s the case and they’re in retirement then their incomes could drop dramatically with the banks cutting dividends and they will have to pull in their living expenses for the next year or so.”
Most super funds affected
It’s not only SMSF investors that will feel the pain.
Chant West research chief Ian Fryer said a typical growth fund, where most Australians have their super, typically has an allocation of 70 per cent to growth assets, such as shares and property, and 30 per cent to defensive assets, such as bonds as cash.
Australian shares typically make up 30 percentage points of that growth allocation.
“Of that 30 per cent, 25 per cent will be in the banks meaning the fund’s overall exposure to financials is 7.5 per cent,” Mr Fryer said.
Dividend cuts will affect inflows to super funds, and if the earnings of the banks fall, as seems likely during the worst economic shock in 90 years, then bank dividends will be restricted to 50 per cent of a lower amount.
On the other hand, Mr Fryer said forcing banks to hold more cash could help build value for shareholders, restricting losses.
Bank analysts are pessimistic about the outlook, though.
Research from UBS analysts said: “Given the uncertain economic outlook, the Melbourne lockdown and potential for future lockdowns, business credit growth is likely to continue stalling from here.
“In fact, we believe there may now be a case to argue for negative business credit growth. UBS Economics Team has adjusted its credit growth forecasts to assume a 2 to 3 per cent contraction in business credit next year … and -4 to 5 per cent for the next two years.”
Although demand for housing credit may rise, UBS says the next two to three years will nonetheless be hard for the banks.
It predicts dividends will stay below 2019 levels throughout that period, as the chart above shows.
And regulators are making similar predictions, according to Stuart Jackson, bank analyst with Montgomery Investment Management.
“Already, hardship provisions [which allow banks not to make provisions for troubled customers] have been deferred for another six months,” he said.
The fact that APRA has allowed the banks to pay dividends is a positive sign, says Reuben De Barros, an equities analyst with IFM Investors.
However, “it has allowed them to push a tightening of capital requirements out to January 2023”.
Many managed funds and ETFs will also be hit by the dividend cuts.
Mr Abrahamsson said “a typical balanced ETF might have a 20 per cent weighting to Australian shares and 7 per cent of them would be in banks”.
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