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The new dividend threat facing ASX big bank stocks

Shares in the big four banks are leading the market lower this morning after New Zealand ordered its banks to stop paying dividends.

The Commonwealth Bank of Australia (ASX: CBA) share price and National Australia Bank Ltd. (ASX: NAB) share price tumbled more than 5% each in early trade.

The Australia and New Zealand Banking Group (ASX: ANZ) share price also lost 5.2% to $$16.16 while the Westpac Banking Corp (ASX: WBC) share price declined 4.5% to $15.95.

In contrast, the S&P/ASX 200 Index (Index:^AXJO) (ASX:XJO) slumped 3.1% at the time of writing.

How New Zealand dividends work

It’s interesting that the banks didn’t mark this update on the ASX as price sensitive when it clearly is, judging from their share price reaction!

The New Zealand banking sector is dominated by the big four. The sharp losses in their share prices comes despite reassurances from CBA and NAB that the move won’t have a material impact on their balance sheets.

The Reserve Bank of New Zealand (RBNZ) decided to stop banks from beaming cash back to their motherships due to the economic hit from the COVID-19 pandemic. The restriction applies to all banks regardless of how strong their cash buffers are.

Link between CET1 and dividends

Dividends from their NZ subsidiaries bolster the CET1 ratio of our big banks here. Australian regulators require the banks to have a minimum CET1 ratio of 8%. The ratio reflects the amount of cash held against their loans.

If RBNZ’s move were to impinge on the big four’s CET1 ratio in Australia, it will force them to make deeper than expected cuts to the ordinary dividends that they can pay to shareholders.

CBA and NAB are in the clear while ANZ Bank didn’t address this issue and pointed out that it cannot redeem NZ$500 million worth of its Capital Notes on 25 May this year.

Westpac has yet to issue an update, but it may be distracted by the appointment of its new chief executive Peter King.

Bank dividend outlook

Analysts are already pencilling in dividend cuts of around 30% over the next two years from coronavirus.

I suspect the new development from across the Tasman won’t change dividend forecasts for the group.

If you are wondering why investors seem to be reacting so badly to this, there are two possible reasons.

Foolish takeaway

First, no one likes uncertainty, especially in this climate which makes forecasting a near impossible job, as it is.

Second, some investors might be worried that the Reserve Bank of Australia could impose a similar dividend restriction on the banking sector.

Afterall, the reasons cited by RBNZ for the unprecedented move is applicable in the Australian context too.

If ASX banks can’t pay dividends, or have much more limited capacity to pay one, there is really no reason to hold their shares during the COVID-19 crisis.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Commonwealth Bank of Australia, and Westpac Banking. Connect with him on Twitter @brenlau.

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.