Why the Big 4 banks will slash their dividends

Imagine Commonwealth Bank of Australia (ASX:CBA) with a 3.7% dividend yield.

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

If you're thinking of buying shares in Australia's biggest banks for their dividends, you might want to think again.

According to some estimates, the dividend payout ratio from Australia's Big 4 banks could fall to a mere 50 per cent, down from their current range of between 70 per cent and 80 per cent, according to The Australian Financial Review.

This is to allow the banks to increase their equity capital levels to meet tougher standards set by the Australian Prudential Regulation Authority (APRA) and the Financial Stability Board (FSB). And to ensure they're capable of withstanding a severe downturn in the Australian, or the global economy.

The standards require the banks to hold more capital against every dollar of loans they write to customers. This enhances the strength of their loan books and protects taxpayers from potentially having to bale the banks out if conditions get too tough for them to handle.

On the other hand, it isn't so great for shareholders of the banks. As highlighted by the AFR, Bank of America Merrill Lynch estimates that the banks have raised $27.3 billion of extra common equity tier one, or CET1, since June 2014 through share issues, asset sales and dividend reinvestment plans. Unfortunately, they're likely going to have to raise tens of billions more by relying on similar initiatives.

Another path the banks will likely be forced to go down is cutting their current dividend payments. For a long time, investors have relied on the generous fully franked distributions that hit their bank accounts every six months, but that seems likely to change in the coming years.

Let's assume for a moment that Commonwealth Bank of Australia (ASX: CBA) maintained a dividend payout ratio of just 50%, instead of the 75.1% it achieved in the 2015 financial year. All of a sudden, its 420 cent per share full-year dividend becomes 280 cents per share, putting it on a fully franked dividend yield of 3.7% instead of 5.6%.

National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) are all in a similar boat. Although they all maintain solid fully franked dividend yields today, there is no guarantee they will be as solid in the next few years.

It needs to be remembered that the example regarding Commonwealth Bank provided above is only hypothetical, and the banks will likely record modest earnings growth over the next few years, but the point is clear. Investors should not rely too heavily on the banks' dividend streams, nor should they invest in the banks solely because of the yields on offer.

In my opinion, there are plenty of other great dividend-paying companies that represent far better buys today.

Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »