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Fund manager warns that ASX bank dividends facing multi-year bad debt hit

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Don’t let the recent share market rally fool you in thinking that the COVID-19 blues are fading. If anything, ASX banks are on the cusp of a consecutive multi-year bad debt hit to earnings and dividends.

The warning comes from fund manager Janus Henderson who told the Australian Financial Review that banks will be forced to shore up their capital buffers by cutting capital management programs and dividends.

ASX banks’ dividend threat

This isn’t what ASX bank investors want to hear, especially when investors are looking forward to Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking GrpLtd (ASX: ANZ) resume dividend payments.

Both banks suspended the payout at the recent half year profit reporting season, while National Australia Bank (ASX: NAB) slashed its interim dividend by nearly two-thirds.

Investors are nervously watching Commonwealth Bank of Australia (ASX: CBA), which will show its dividend hand next month when it turns in its full year report card. CBA’s financial year end is different from the other three big banks.

Is CBA next to cut dividends?

Experts are divided on what CBA will do. Some believe it will take the conservative approach and defer its dividend decision till November to get a better idea of the earnings impact from coronavirus.

Others are more bullish and believe the worst of the economic impact from the pandemic is behind us and CBA will only cut its dividend by a relatively modest amount. This bullish outcome will likely fire-up the CBA share price.

I was in the more bullish camp, but that was before Victoria was forced into a second lock-down. Now there’re fears that New South Wales may follow suit with community transmission of the virus at Star Entertainment Group Ltd (ASX: SGR) and the Crossroad Hotel.

Start of the bad debt downgrade cycle

“We think that banks will continue to need to shore up capital,” the AFR quoted Janus Henderson’s head of Australian fixed interest, Jay Sivapalan, as saying.

“They will go through a multi-year reporting period and cycle of reporting a higher level of provisioning.”

The provisioning for bad debt will need to rise as the chance of loan delinquencies rise. Around 800,000 mortgagees and small businesses have asked Australian banks for a repayment holiday.

These borrowers are struggling to service their loans due to widespread job losses and a drop in consumer spending from the COVID-19 fallout.

Foolish takeaway

However, the situation on the ground may not be as dire as the number suggests. Many mortgagees have suspended loan repayments as a precaution even though they aren’t impacted by the COVID-19 shutdown.

These customers are starting to commence paying their loans again and I think the circa $6 billion in provisioning set aside by the big four may about enough to see them through.

However, this assumes that the current lockdown in Victoria isn’t as damaging as the first and the rest of Australia continues to stay relatively coronavirus free.

But I will admit, this assumption is starting to look a tat optimistic right now.

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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 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 Scott Phillips.

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