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Why investors are salivating at the return of juicy bank dividends

Investors, who had to subsist on a stingy dividend regime last year, are now licking their lips at the prospect of richer, more tasty returns.

Karen Maley
Karen MaleyColumnist

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Long-suffering bank shareholders are eagerly awaiting the release of the Commonwealth Bank's half-year results next month, which they hope will mark the end to the subsistence rations doled out to them during the pandemic.

These hopes were bolstered last month when the Australian Prudential Regulation Authority scrapped its previous ruling that forced banks to cap shareholder payouts at 50 per cent of profits, although it did counsel boards to maintain "a prudent approach" to dividend payments.

Investors are praying that the boards of the four major banks will interpret "prudent" to be consistent with paying up to 70 per cent of profit to shareholders.

All bank shareholders will be watching to see much of CBA's profit CEO Matt Comyn gives to shareholders next month. Dominic Lorrimer

This is well below the 80 per cent-plus payout ratios that the big banks lavished on their shareholders in 2019, but significantly above the miserly payout ratios of just over 50 per cent last year.

It's likely that whatever ratio the Commonwealth Bank board opts for when it announces its interim dividend next month will set a standard across the industry, with other major bank boards reluctant to venture too far above or below this figure.

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Leading banking analyst Brian Johnson tips the banks will return to payout ratios of about 60 to 70 per cent in the first half, and that they may even contemplate share buybacks or other capital initiatives in their second-half results.

The combination of low credit growth and continuing profitability means that the banks are generating a lot of capital.

Brian Johnson, Jefferies' banking analyst

"What's happened is that JobKeeper injected a massive amount of money into the economy, and unemployment numbers look better than people thought they would," says Johnson, who is head of bank equity analysis at the financial services group Jefferies.

"And there's been massive deposit growth so capital ratios look so much better, and the banks have strengthened their balance sheet provisioning."

At the same time, he points out, loan growth has been extremely anemic. "Owner-occupied housing is the only sector that's growing. Lending for investment housing has been insipid, along with personal credit and lending to small businesses.

"The combination of low credit growth and continuing profitability means that the banks are generating a lot of capital."

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But even apart from curiosity over the size of the bank's interim dividend payments, there are other reasons why investors will scrutinise Commonwealth Bank's half-year results even more closely than usual.

In the first place, investors will look for the country's largest bank to confirm signs that the bad debts that the banks have incurred as a result of the pandemic are much smaller than feared even a few months ago.

Figures released by APRA earlier this month pointed to a further sharp slide in the number of deferred home loans and small business loans in November.

Investors are hoping that when it releases its results, Commonwealth Bank will provide more up-to-date information confirming that this propitious trend continued into December and January.

Jefferies' analyst Brian Johnson. Peter Braig

This would confirm indications that the big banks have managed to achieve a very difficult manoeuvre; firstly in sheltering small businesses and individuals whose income shrivelled as the pandemic caused economic activity to collapse, and subsequently by encouraging huge numbers of borrowers to resume loan repayments.

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Needless to say, investors, regulators and Canberra will be listening closely to any comments Commonwealth Bank boss Matt Comyn makes about the economic outlook.

There's no doubt that confidence has risen as economic activity has rebounded, and as the rollout of a coronavirus vaccine program has been brought forward.

Still, as the head of the country's biggest bank, Comyn has unparalleled insight into those segments of the economy – including parts of the tourism industry – that have been hard-hit by the pandemic, and so there will be keen interest in his views on what lies ahead.

Another area of interest will be the increasing importance of online banking. The pandemic has accelerated the pivot towards digital and mobile banking, as people shied away from visiting bank branches.

But this has intensified the pressure on the banks to keep investing heavily in technology or risk losing customers to competitors with flashier apps.

Finally, of course, the Commonwealth Bank results will be a fascinating insight into the intense competition between the banks to write new home loans, particularly since demand from owner-occupier has hit historically high levels as a result of ultra-low interest rates.

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Commonwealth Bank, which is the country's largest home lender and controls around one-quarter of the market, has established a reputation as a formidable competitor in home lending.

Home loan battleground

This was evident in its trading update for the first quarter 2021, released last November, in which the bank disclosed that it had increased the size of its housing book by $5.6 billion in the three months to September 2020, growing at twice the pace of the overall system.

Still, its major competitors are determined to boost their market share, both by offering tantalisingly low home loan rates and by improving their efficiency in processing home loans.

And this means investors will watch closely to see whether Commonwealth Bank is continuing to claw market share off its rivals in the lucrative, but highly competitive, home loan market.

The ferocity of the competition in the home lending market is evident from the latest APRA monthly statistics for November 2020.

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These show that the Commonwealth Bank dominated the home loan market, with $304.6 billion owner-occupied loans and $158.6 billion investment loans on its books.

Westpac was in second place, with $228.6 billion owner-occupied loans and $176.1 billion investment loans.

But there's been an upset among the Melbourne-based banks, with ANZ Bank – the erstwhile laggard – overtaking National Australia Bank.

According to APRA figures, ANZ had $174.5 billion owner-occupied loans and $86.8 billion investment home loans (a combined total of $261.4 billion) on its books as at November 2020.

Potential disappointment

This put it ahead of NAB, which had $157.5 billion of owner-occupied loans and $102.6 billion of investment home loans (for a total of $260.1 billion).]

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One potential disappointment for shareholders is that although all the big banks boast a strong capital position – all have common equity tier 1 ratios well above the 10.5 per cent level "unquestionably strong" level set by APRA – bank boards could decide that it's "prudent" to defer buybacks or other capital management initiatives until the economic outlook is more certain.

Johnson points out that there are a few factors that could cause banks to hit the pause button on plans for capital returns.

In the first place, he notes extremely low bond yields are hurting the banks' net interest margins.

Secondly, banks' share prices have already rebounded so strongly that any capital management initiatives won't be as earnings-per-share accretive as they would have been in the past when share prices were lower.

Finally, Johnson notes that APRA has yet to release its final calibration of the Basel 3 [the international regulatory framework for banks] rules.

"These could prove to be a marginal negative for Westpac, because there's likely to be a higher risk weighting for riskier housing loans, and marginally positive for NAB because there'll likely be a lower risk weighting for secured loans to small- and medium-sized businesses", he says.

The author owns shares in the major banks.

Karen Maley writes on banking and finance, specialising in financial services, private equity and investment banking. Karen is based in Sydney. Connect with Karen on Twitter. Email Karen at karen.maley@afr.com

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