Hungry for Dividends? Then don’t buy the banks

The RBA is warning investors of a potential cut to bank dividends in the near future as a result of tougher capital requirements according to The Australian Financial Review.

Dividend cuts within the sector have been rumoured for some time now. Historically, the big four banks have been seen as the ‘go to’ for lucrative and reliable fully franked dividends, which is why they are among the most popular shares across the ASX. In addition, they are four of the country’s biggest corporations and are considered the pillars to the national economy.

However, it is their importance within the economy that also makes it imperative that they maintain sound financial backing. They need to remain “unquestionably strong” in case of another economic downturn which would help to protect both bank customers, as well as taxpayers by helping to prevent the need for a potential bailout.

While the banks collectively raised billions of dollars’ worth of new capital by issuing new shares in 2015, it is believed they will still need to improve their capital backing even further. While further capital raisings could be called upon, cuts to the banks’ dividends are also seen as a likely alternative. Indeed, lower dividends – or at least, lower payout ratios – would help the banks to retain more cash to put towards their capital reserves.

Australia and New Zealand Banking Group (ASX: ANZ) has already cut its dividend. In March, it declared an interim dividend of 80 cents per share (fully franked), down from the 86 cent dividend per share announced in March 2015.

Meanwhile, Commonwealth Bank of Australia (ASX: CBA) elected to keep its full-year dividend unchanged in financial year 2016. National Australia Bank Ltd. (ASX NAB) and Westpac Banking Corp (ASX: WBC) have kept their latest dividends unchanged (compared to the previous period) as well.

Australia’s banks are among the most profitable banks in the world, but their returns are likely to come under pressure as a result of higher capital requirements. According to The Australian Financial Review, analysts expect the Return on Equity for the big four banks to average 12.5% over the next couple of years, down from around 20% before the Global Financial Crisis and well below what bank shareholders have grown accustomed to.

Of course, this does increase the chance that the banks will take on more risk in order to maintain their returns, although this is likely something the regulators will be paying close attention to.

The Reserve Bank of Australia cut interest rates to a record low of 1.5% in August. While it is debatable whether or not they will cut the cash rate any further from here, it’s also seen as very unlikely the central bank will raise interest rates in the foreseeable future.

As such, low interest rates are likely here to stay. While that makes dividend shares much more appealing (given they are capable of generating greater returns than term deposits or government bonds in this environment), investors may want to look beyond the banks at some of the less appreciated dividend shares.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. 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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