Australia's 'big four' banks – Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) – have experienced earnings tailwinds of late, due to customer remediation costs, low interest rates and slow economic growth.
Banks have also been required to meet APRA's new "unquestionably strong" capital benchmark requirements by 1 January 2020. This has caused Westpac to initiate a significant $2 billion capital raise, while the Commonwealth Bank shaved 90 basis points from its dividend to support its capital position. In Westpac's full year result, the company announced a 15% dividend cut to 80 cents per share (CPS) from 94 cps, while NAB also reduced its dividend by 16% to 166 cps.
So, in the midst of further regulatory requirements, a challenging operating environment and earnings volatility, which bank has the safest dividends?
Dividend payout ratio and earnings
While many factors come into play, I believe a company's dividend payout ratio and its earnings potential form the baseline for assessing whether its dividend is safe. The dividend payout ratio represents the percentage of earnings that are paid out as a dividend. Banks have typically aimed for a dividend payout ratio around 70–80%. The lower the payout ratio, the more room there is to maintain a dividend if earnings go backwards.
Westpac's decision for a dividend payout ratio of 97% in H1FY19 would inevitably result in a dividend cut. The ratio was simply too high and unsustainable in today's low interest and slow growth environment. To add insult to injury, Westpac's earnings were hit the hardest compared to the rest of the banks. Its full year results saw statutory net profit fall 16%, earnings per share decrease 16% and net interest margins retreat 10 basis points to 2.12%. I believe Westpac is in the weakest position of all 4, given its significant dividend cut, poor earnings and capital raising.
Surprisingly, NAB also cut its dividend by 16% from 198 cps to 166 cps. In its full year result, the bank reported FY19 revenues were down 4.2%, however, excluding customer-related remediation, revenues actually increased by 1.1%. While revenues are steady, NAB has the lowest CET1 ratios out of the big four banks. Its weak CET1 ratio could result in pressure on its dividends in the future.
The Commonwealth Bank delivered a sound Q1FY20 update with unaudited cash net profit up 5% excluding notable items and operating income up 3%. It did note that 2019 final dividend payments had a 90 basis point cut to further strengthen the company's CET1 ratio. CBA has also been the only bank to provide a Q1FY20 trading update. Its result alludes to lower dividends but remains resilient in this challenging operating environment.
ANZ's full year report cited similar growth headwinds, with statutory net profit after tax falling 7%. However, the company was the only bank that managed to keep its dividend year-on-year. Its dividend also only represents a payout ratio of 70%, which gives it the flexibility to increase should further headwinds arise. ANZ also has the strongest CET1 ratio, significantly above its peers.
Foolish takeaway
ANZ has been the only bank to maintain its dividend payout at a reasonable, sustainable dividend payout ratio. As well as the strongest CET1 ratio across all banks, I believe ANZ has the safest dividends for the short–medium term.
