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CBA may need to cut its dividend

Commonwealth Bank of Australia (ASX: CBA) may soon need to cut its dividend, according to Morgan Stanley.

The Australian Financial Review is reporting that Morgan Stanley said to clients that the sale of Commonwealth Bank’s life insurance and global asset management businesses will create an earnings hole in the near future, leading to a potential dividend cut if the bank is to maintain its current dividend payout ratio.

It’s not a simple case of CBA just using the $4.13 billion proceeds from the sale of Colonial First State Global Asset Management (CFSGAM) to Mitsubishi UFJ Trust and Banking Corporation (MUTB) to buy another business to fill the earnings hole. CBA has to hold more capital to hit APRA’s ‘unquestionably strong’ target.

In FY18 the CBA dividend represented a payout ratio of 80% of earnings, or 75% if the AUSTRAC penalty of $700 million is excluded. This payout ratio does still give the bank some breathing room, but it doesn’t leave much for re-investment back into the business, nor is it creating a lot of money to add to the balance sheet’s strength.

All of the above figures assume that Commonwealth Bank can maintain its current level of earnings, excluding CFSGAM. The international wholesale funding pressures haven’t disappeared and the falling Australian property prices could lead to rising bad debts. It doesn’t have to be an economic catastrophe for CBA’s bad debts to slowly-but-steadily rise from the cyclical lows we see today.

I do rate CBA and Westpac Banking Corp (ASX: WBC) as having higher quality Australian loan books than Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB).

Foolish takeaway

CBA is trading at 13x FY19’s estimated earnings with a grossed-up dividend yield of 8.4%. Whilst CBA is trading attractively compared to recent years I still don’t think it’s a buy, I think the best time to buy banks is in the depths of a recession.

Instead, if you’re after income I think these three top-quality ASX dividend shares are better choices for a yield-focused portfolio.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

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