Sector Report

Australian banks: Dividendosaurus

by Brian Johnson / May 20, 2016

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Since peaking in April 2015, the Australian banks have underperformed as the long-running AUD dividend yield carry trade unwinds. On a global basis banks are pressured by low interest rate policy settings. The 1H16 earnings disappointed and slow credit growth/rising loan losses see forward EPS growth set to slow. Material dividend cuts are likely should regulatory capital intensity rise. On a proforma basis we estimate the major banks are A$33bn short of CET1 capital.

Fears of a collapse in the Australian housing bubble have resurfaced and we are concerned regarding WA housing, looming settlement risk in Melbourne/Brisbane and the risk that China capital inflows into Sydney/Melbourne housing are disrupted. Increased scrutiny sees the bank oligopoly pricing power diminishing on lending products which is problematic as interest rates fall.

Seven things investors should know:

  1. Globally, banks look challenged by policy settings. Australian banks are relatively expensive, challenged by lower interest rates face the prospect of rising loan losses and rising capital. The long running Australian bank AUD dividend carry trade looks to be unwinding
  1. We think the major banks are still A$33bn short of CET1 capital – the recap cycle is not yet over
  1. Australian bank forward EPS growth is set to slow.
  1. Rising CET1 and mid-cycle earnings would see sustainable dividend payout ratio cut from 70% to 60% and dividends fall 7% to 36%
  1. Increased scrutiny sees the banks losing their pricing power on lending products which may be problematic in a falling interest rate environment
  1. Fears about a collapse in the Australian housing bubble remain elevated.
  1. On notional mid-cycle recapitalized earnings, the Australian banks don’t look particularly cheap.