With results season in full swing, the Australian Prudential Regulation Authority (APRA), the prudential regulator for banks and insurance companies, recently provided guidance on its expectations for dividend distributions.
APRA has indicated that for the remainder of the calendar year boards for both banks and insurers should seek to retain at least half of their earnings when making decisions on distributions to shareholders.
Readers will recall a number of financial institutions suspended their dividends earlier in the year following APRA’s suggestion that boards “seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer” (which was a polite way of saying don’t pay any dividends). Significant uncertainty surrounding COVID-19 prompted regulators around the world to impose a moratorium on distributions to shareholders, with both European and New Zealand regulators recently extending (this moratorium).
We suggested at the time that the prospect of ‘deferred’ dividends being recouped were low once banks resumed paying dividends later this year. For now, we see little to suggest this will change (there is certainly no clarity from APRA in this regard at the time of writing, so we assume they won’t be in the mix). Shareholders will have to be patient until greater certainty around the impacts of COVID-19 materialises. A slowing housing market and subdued levels of credit growth also suggest it will be some time before dividends return to pre-COVID-19 levels (see Figure 1).
Figure 1: Dividend per share and dividend yield
Source: Bank disclosures, Bloomberg. ‘e’ denotes consensus analyst estimates. Note: excludes franking credits
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Australia’s banks entered the current pandemic having built up strong capital buffers boosted by a number of years of favourable economic performance (which also enabled them to distribute utility-type dividends to shareholders for a number of consecutive periods). APRA has seemingly recognised this. However, APRA is also apparently keen to see earnings (and by extension, dividends) as a first line of defence, with the following expectations accompanying the updated guidance on dividends:
- Utilise dividend reinvestment plans and other initiatives to offset the diminution in capital from capital distributions.
- Make use of capital buffers to absorb the impacts of stress, and continue to lend to support households and businesses.
For now, we assume banks will offer dividend reinvestment plans consistent with recent historical experience, and will make use of capital buffers (that is, reporting capital ratios below the “unquestionably strong” benchmark), if required. We previously covered off the sufficiency of capital to absorb an increase in losses stemming from COVID-19 here.
There is also the matter of how earnings are measured. For example, is it based on statutory or cash basis (we suspect the former). Although not considerable, the difference between payouts on a statutory and cash earnings basis is circa +/- 5%. CBA has a target range of 70%-80% on a cash earnings basis, while both NAB and Westpac target 70%-75% on a cash base (excluding notables) (ANZ does not communicate a specific target) (see Figure 2 for recent dividend payouts). Nuances aside, there is clear consensus that dividends will take a step-down for the foreseeable future (see Figure 1).
Figure 2: Dividend payout ratios (cash basis)
Source: Bank disclosures. *Deferred (did not declare) 1H20 dividends.
Despite the resumption of dividends, we see little immediate impact for bondholders. Given the capital headroom above the point at which an issuer would be required to either write-off or convert some or all of its subordinated debt to common equity (see Figure 3), we believe the more severe risk to creditors of either deferred coupons (in the interim) or conversion/write-down of principal at a later point is very low.
Figure 3: Common Equity Tier 1 (CET1) Ratio sensitivity to economic scenarios
Source: Major Bank disclosures. Demonstrates CET1 sensitivity to credit risk weighted asset migration over two years in response to modelled economic scenarios as a result of COVID-19.
CET1 headroom above Capital Conservation Buffer and Loss Absorption Trigger Point shown in parentheses, respectively.
* 1H20 pro-forma (post-capital raise)
^ CET1 does not include ~67-77bps (~3.5bn) of additional capital proceeds from announced asset divestments.