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Broker warns that Big Four bank dividends are at risk of being cut

Investors beware! Big banks may be forced to commit the cardinal sin and cut dividends in the next few years, according to the analysts from Citi.

They argue that deteriorating asset quality and tighter regulations on the amount of cash banks will have to hold to protect themselves from external shocks will leave them short of cash to sustain their generous dividend policy.

This means banks will have to trim their dividends in three years with National Australia Bank Ltd. (ASX: NAB) tipped to be the biggest offender as Citi is forecasting its dividend will be cut by 15.1% to $1.68 a share in 2017-18.

Commonwealth Bank of Australia (ASX: CBA) is the second worse with a 13.3% cut to $3.64 a share when compared to what it paid in the last full year, while Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) will lower their dividends by 7.9% and 7% to $1.64 and $1.69, respectively, over the same period.

Cutting dividends will bring the payout ratios for the big banks to around 60% to 70%, which is seen to be more sustainable by the broker.

Citi believes the payout ratio, which is the percentage of the banks’ net profit that’s paid out in dividends, for the sector is heading towards 80% this financial year.

However, I do not share Citi’s pessimism and neither do most other brokers, but this is assuming Australia can avoid a recession and there are no “Black Swan” events (a big and unexpected economic shock like the global financial crisis).

I suspect the key reason for Citi’s bearish take on bank dividends is primarily due to its lower than consensus profit forecasts for the Big Four.

The average consensus payout ratio for the Big Four stands at around 76% for 2014-15 and 74% for the following year.

These figures are close to five-year historical payout ratios and the “sustainable” level touted by Citi looks a tat too conservative even in light of the headwinds buffeting the sector.

Further, I believe the boards of the Big Four will only cut dividends as a last resort because they know their jobs could be on the line as investors will likely revolt.

But a dividend cut is not all bad news. Even if Citi is proven right and dividends are cut, Citi admits that bank yields will still look attractive on a relative basis.

Let us hope Citi is wrong.

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Motley Fool contributor Brendon Lau owns shares of Commonwealth Bank of Australia, Commonwealth Bank of Australia, National Australia Bank Limited, and Westpac Banking. Follow me on Twitter - https://twitter.com/brenlau

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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.

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