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What a credit downgrade of the big four ASX banks mean for investors

Shares in the major ASX banks will be under stress today as they face pressure on several fronts to suspend their precious dividend payments.

It doesn’t help that the S&P/ASX 200 Index (Index:^AXJO) will start the trading day on a weak footing due to a negative lead from Wall Street.

But that’s more a secondary consideration for shareholders in the big four after ratings agency Fitch Ratings downgraded their credit rating late last night.

What’s a credit rating

A credit ratings agency assesses the ability of a company to repay its loan obligations and the rating it gives a company will determine the interest rates it will have to pay for debt.

The less risky a borrower is, the lower the rate they will typically pay. It works much like a credit score for consumers.

Fitch, which is one of the three major ratings agencies, downgraded the ratings for Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB).

More downgrades likely

The agency not only cut the longer-term and shorter-term ratings on the big four, but it left them on “negative” watch. This means there is a real risk that Fitch will downgrade the banks again.

Fitch justified the move to lower the ratings for the group by one notch to “A+”. The agency cited the challenging environment that the banks are operating in due to the COVID-19 pandemic.

The big banks are expected to shoulder part of the burden to stop companies from going under due to the shutdown of the Australian and New Zealand economies.

Spotlight on bank dividends

The downgrades come at a time of heated debate over whether the majors should be paying a dividend to shareholders. A ratings downgrade would, in theory at least, impact on the availability of capital the banks can access.

The Australian banking regulator, APRA, is urging the banks to curtail their dividend payments to shareholders. Bank of Queensland Limited (ASX: BOQ) announced today it would suspend its interim dividend until the coronavirus threat passed.

Credit ratings matter less in this climate

However, a ratings downgrade in this environment is largely academic – just as it was during the GFC. All lending institutions around the world are facing the same deterioration in their credit quality due to the pandemic.

Also, Fitch’s move ignores the strong belief that the federal government will act as a guarantor to save the big banks from collapse. The government won’t guarantee dividends, but credit ratings have nothing to do with dividends.

Further, the Reserve Bank of Australia (RBA) is providing $90 billion in cheap money to the banks to ensure they have sufficient capital to lend.

I believe the RBA will pump more cheap liquidity into the banking system if there is any marked increase to the cost of funds for Australian banks.

Foolish takeaway

Coming back to dividends, I think its unavoidable that the banks will have to cut their half year dividends. The real question is whether they suspend or pay a smaller one.

BOQ’s move will make their decision to stick to paying a smaller dividend next month a more difficult one. But I note that QBE Insurance Group Ltd (ASX: QBE) will still keep its promise to shareholders after considering APRA’s appeal.

Moreover, BOQ’s financial position is significantly inferior to that of the big banks. This is why I suspect the big four will continue to pay a distribution – at least in the shorter term.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Commonwealth Bank of Australia, National Australia Bank Limited, and Westpac Banking. 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.