ANZ Dividend Cut Inevitable?

This story features ANZ GROUP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: ANZ

By Greg Peel

As was noted in FNArena’s recent Australian bank update, Beyond Reporting Season, brokers were surprised the recent bank reporting season did not reveal any increase in bad and doubtful debts (BDD) across the sector. But analysts are convinced it’s only a matter of time.

BDDs peaked after the GFC and have gradually fallen ever since, reaching historically low levels by the last bank reporting season in May. A low interest rate environment and banks’ stricter lending criteria mean fewer borrowers have been getting into trouble, and fewer applicants have been granted loans in the first place.

Eventually BDDs will cycle back towards more “normal” levels, bank analysts believe. Meanwhile, the banks may have all raised new capital and repriced mortgages to cover fresh regulatory requirements but more could yet be needed as both global and domestic regulatory requirements are still being assessed and defined. If we combine the two possibilities – increasing bad debts and yet more onerous capital obligations – something has to give. That would be dividends.

Of all the FNArena database brokers, Morgan Stanley was the most insistent from six months ago that all four major banks will be forced to raise capital to cover global “too big to fail” requirements, an additional domestic TBTF buffer and tighter mortgage risk weighting. Other brokers hoped a combination of time to comply, allowing for organic capital growth, and dividend reinvestment plans might get some banks over the line. This was not the case.

Morgan Stanley is now the most insistent among brokers the banks may well be forced to cut their dividends. Of the four, the broker rates ANZ Bank ((ANZ)) as the most likely.

ANZ reset its dividend payout ratio to 65-70% in 2013 from a previous 67%, with “a bias towards the upper end of the range in the near term”. Only last week the bank reiterated that it expects to fully frank its dividends for the foreseeable future. But ANZ’s Asian exposure is throwing up two issues.

Firstly, ANZ only generated 61% of its FY15 profit in Australia. Eventually the bank must run out of franking credits. Secondly, while Australia’s BDDs remain historically low for now, ANZ’s Asian BDDs have risen, especially in Indonesia.

Moreover, when ANZ paid a flat year on year final dividend for FY15 it pushed its payout ratio to 71%, Morgan Stanley notes, above the bank’s stated range. If the dividend were to remain flat that ratio would hit 75% in FY17. Morgan Stanley further calculates that even at a 70% payout, FY16 dividends could only be around 90% franked. Or looking at it the other way, full franking could only be sustained on a payout ratio of 60-65%.

While ANZ’s board may feel anything less than full franking which Australian banks have come to take for granted might not be well received by shareholders, Morgan Stanley believes a slight trim (80-90%) is no big deal and the bank is likely to set its dividend policy based on a sustainable payout ratio rather than shareholder tax issues. If there are no longer excess franking credits to absorb, why persist with an above-range payout?

ANZ has a new CEO. New CEOs are notorious for resetting the bar lower shortly after they arrive, copping short term pain but rebasing for upside during their tenure. Resetting ANZ’s dividend payout ratio would be something the new CEO may well be considering, Morgan Stanley suggests.

To put the numbers into perspective, were ANZ to drop its payout right down to 60% this would represent a dividend cut of 17% to 150c (albeit fully franked), Morgan Stanley calculates. If ANZ’s bad debt impairments were not to rise as the broker is forecasting, the cut would be 15% to 154c.

Among the FNArena database brokers, there is a consensus preference for the two big retail banks over National Bank (business banking bias) and ANZ (Asian exposure). However Commonwealth Bank’s ((CAB)) persistent sector premium means broker consensus has CBA as third preference behind Westpac ((WBC)) and ANZ, with NAB least favoured.

ANZ attracts four Buy, three Hold and one Sell (or equivalent) ratings on an average target of $30.90, suggesting some 18% upside from the current traded price. Forecasts suggest a yield at the trading price of 7.0% for FY16, fully franked, but clearly both are subject to possible reductions.
 

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