There is some good news for income-seeking investors with possible buybacks in the pipeline as the big banks reported a lift in dividend payments in the May reporting season.

Based on the recent first-half fiscal 2021 reporting season, the big banks – Westpac, ANZ and NAB – proved their resilience, emerging from the pandemic with solid balance sheets and stronger capital positions.

Just a year ago, Australia was in lockdown.  A total of $136 billion in loans was deferred in the banking sector. At the same time, Australian Prudential Regulation Authority (APRA) pushed banks to take a prudent approach to capital management, advising the sector to cap shareholder payouts to 50% of profits.

Fast forward to May 2021, and the banks are on track to boost their dividends while all three reported a lift in profits compared with the second half of 2020. Westpac’s first-half result was solid with a cash profit of $3.5 billion, up 119%. ANZ followed with a cash profit of $3 billion, up 45%, while NAB reported a $3.3 billion cash profit, up 48%.

On Morningstar’s numbers, the three paid $6.1 billion in dividends this half, compared to around $1.6 billion the first half of 2020. ANZ paid an interim dividend of 70 cents per share (67% payout ratio), NAB paid 60 cents per share (59% payout ratio), and Westpac paid 58 cents per share (60% payout ratio).

Importantly, loan impairment provisions – the amount banks set aside for loan defaults - was scaled back. Westpac released some of the loan provisions it had taken last year with an impairment reversal of $372 million in the first half. Similarly, ANZ released half a billion in credit provisions³ while NAB wrote back $128 million in loan impairment provisions.

However, Morningstar believes there was scope to deliver more dividends to shareholders. “We thought the banks would pay out a little more than they did in the first half, with management keeping some room to maintain or grow dividends in the second half even if they don’t have the same sort of benefit from releasing loan impairment provisions,” Morningstar bank analyst Nathan Zaia said.

Buybacks in the pipeline?

Nevertheless, Zaia expects a positive outlook for bank dividends. “If the banks can grow their earnings, and stick to a 70% to 75% payout, then dividends will be higher in the medium-term,” Zaia said.

He believes these payout ratios will be sustainable, leaving the bank enough headroom to still fund growth in the loan book and take advantage of investment opportunities which emerge. This is before we even start to get to the excessive capital positions of the banks, which could deliver more on the dividend front. Indeed, Morningstar estimates that combined, the banks are sitting on $33 billion in capital above the 10.5% regulatory benchmark.

“It sounds like the banks will seek to maintain a buffer, say 10.8% to 11%, but that still leaves a couple of dollars per share for each bank which can be returned as a special dividend or used for buy backs,” Zaia said.

The sticking point is the ability for banks to lift earnings. Rates are expected to remain lower for longer, and low credit growth is expected to continue. Zaia notes that earnings for the three banks might not move materially in the short-term given the tailwinds from a mix shift to cheap customer deposits is lessoning.

However, the chance of further releases of loan impairment provisions could more than offset any pressure on the net interest margin – the gap between what banks pay to borrow money and the interest rates it lends at.

Nevertheless, all the majors reported improved home loan volumes. NAB’s home loan growth trended closer to system growth underpinned by improved service levels in the broker channel and eased lending restrictions following the COVID-19 lockdown. Westpac’s mortgage book increased $2.6 billion over the past six months, while ANZ grew home loan balances by 7% in the 12 months to the end of March 2021.

The majors will also focus on improved processes, simplified businesses, and digitisation as part of an ambitious cost-cutting agenda in a bid to manage their margins amid low growth and low rates. Westpac announced an aggressive target to bring costs down by about 15% or $1.5 billion, to $8 billion by fiscal 2024. ANZ is also targeting $8 billion but from a lower base while NAB said it would keep its costs below the $7.7 billion mark by fiscal 2023.

“Cutting costs is definitely necessary in a low-rate environment, but I think the banks strategies on expenses is borne out of necessity too,” Zaia said.

Here he says customers are changing the way they interact with their banks, opting for digital options. This is particularly important in their mortgage businesses. If banks want to grow their market share in home lending, Zaia said they must automate and improve their loan approval times.

The swing factor

Looking ahead, Zaia believes credit growth will be stronger compared to the first half as investors return to the market. But for the Morningstar analyst, the ‘big swing’ factor will be whether the banks will release more of their loan provisions. This would also provide a “nice boost to dividends”, at least in the short-term. He doesn’t see many headwinds around the rolling back of government support measures such as JobKeeper and JobSeeker initiatives, with the number of loan deferrals on the banks’ book substantially falling. Around 97% of deferred loans have resumed repayments.

“If we do start to see unemployment go up, there could be more stress on the loan books, but the government does remain focused on job creation while the housing sector remains robust. With lockdown and travel restrictions eased, top line growth could trend upwards as people begin to spend,” Zaia said.  

For the Morningstar analyst, banks should try and use this resetting period to get away from focusing on a flat costs and increasing dividends from half to half, and just payout what the board views as appropriate for each period.