With Commonwealth Bank (CBA) due to report its full year results on Wednesday, it seems a prescient time to consider the banks and examine the long-term view that they should form an important part of every income-focused stock portfolio.
The COVID-19 pandemic has played an unprecedented role in impacting the profits within the sector and this has flowed through to dividends. In fact, three months ago we saw two of the big four banks (ANZ and WBC) defer their dividends completely whereas National Australia Bank (NAB) paid for its heavily reduced dividend with a chunky capital raising.
Of course, things were a lot scarier three months ago when there were so many uncertainties, and a cautious approach to capital was undoubtedly the right course of action with the banks playing such an important role in keeping the economy from crashing. With the first iteration of JobKeeper coming to an end shortly, and APRA’s (the Australian Prudential Regulation Authority) guidance last week that banks should not pay dividends in excess of 50% of their earnings, uncertainty about how much the banks can pay in dividends remains high. Even APRA’s guidance was a little vague, with the regulator encouraging banks to replace the lost capital through means such as dividend reinvestment plans or capital raisings which begs the question: are the banks really income stocks if they’re paying for dividends by selling new shares?
Determining the payouts of the banks in the short-term is less important in our view than the long-term impact from the pandemic. Undoubtedly the extended lockdowns in Victoria are going to blow out the bad debt expectations, but there is also a good chance that previous write-downs before the reduced cost of JobKeeper were revealed could have been larger than needed. The fact that JobKeeper has been extended (on reduced terms) for another six months probably means the banks will remain cautious until they get a better feel for the lay of the land. Undoubtedly, JobKeeper is keeping many businesses afloat that simply won’t be able to continue once it ends, but the banks are probably getting a good idea of things while in communication with their customers.
One key thing to remember is to not look at the upcoming CBA result and extrapolate it across the entire sector and economy. CBA is the largest home loan provider in the country and as such has the lowest-risk loan book as well – remember that we have yet to see significant property price falls (except perhaps for commercial property) – so it may be able to pay a big dividend even if the rest of the sector cannot.
With all of the negative points mentioned above, it’s easy to forget that over the long-term the banks probably have no option but to continue to pay out big dividends. While the depth of this bad debt cycle is unknown, there will be a day when the pandemic (and recession) is in the rear-view mirror and the banks will stand in a low-growth world with the inability to make acquisitions in Australia (because of anti-competitive reasons) and without the stomach to make acquisitions abroad (after the many mistaken expansions from NAB and ANZ in particular) – what else will they be able to do with their cash but pay out the majority of their profits in dividends?
