Investors should prepare themselves for lower and possibly suspended dividends from the big banks and insurance companies after a raft of powerful forces combined to urge lower payouts.
First and most importantly, the chairman of the Australian Prudential Regulation Authority (APRA) Wayne Byres has written to all bank boards calling for restraint in dividends, buybacks and cash bonuses for executives.
That is a very rare intervention and his language that they should “seriously consider” suspending their decisions on dividend payments until there is more certainty about the economic toll inflicted by coronavirus is sure to be heeded.
While Mr Byres did not explicitly tell boards to freeze their dividend payments, he did say that dividends must first be cleared by the regulator and be at a level that is “materially reduced.”
Capital reserves must be kept high
He was particularly focussed on banks and insurers having adequate future capital reserves, saying “in the current environment of significant uncertainty in the outlook, this can be very challenging”.
“During this period, APRA expects that ADIs (banks) and insurers will seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer,” Mr Byres wrote.
“However, where a board is confident that they are able to approve a dividend before this, on the basis of robust stress-testing results that have been discussed with APRA, this should nevertheless be at a materially reduced level.”
Bank play a crucial role supporting the economy
Mr Byres said banks had a “critical” role in supporting the economy during the crisis, and APRA had temporarily relaxed some capital requirements “with this support very much in mind”.
Against that backdrop, he said APRA expected regulated institutions to “limit discretionary capital distributions” in coming months, which should include “prudent reductions in dividends”.
Rather than returning capital to shareholders, APRA wants that cash used for lending and providing insurance.
The share market has already priced in significant dividend cuts for the major banks, which offer some of the top payouts on the share market.
Banks have different dividend timetables
All three banks completed their first half last week and are due to hand down results and interim dividends later this month and in May.
The guidance suggests that they may consider suspending the interim dividend until the effects of the COVID-19 pandemic become clearer or possibly announce smaller dividend to conserve capital.
Dividend reinvestment plans (DRPs) are likely to be strongly promoted to shareholders as an alternative to cash payments so that the banks can conserve even more capital.
Commonwealth Bank (ASX: CBA) has different reporting dates and just last week paid $3.5 billion in dividends to shareholders for the first half.
It will not need to make a decision on its dividend until its full-year results, which should be announced in August.
Offshore banks told to halt shareholder payouts
Offshore regulators in New Zealand, the UK and Europe have explicitly told banks not to pay dividends at all and in Australia’s case, APRA is likely to be heavily consulted by banks in arriving at an appropriate payout.
Separately, international credit ratings agency Fitch has also put pressure on dividends as well by downgrading its outlook for the Australian banks and their New Zealand subsidiaries from AA- to A+.
The downgrade was driven by the tougher operating environment caused by the COVID-19 pandemic and Fitch kept ratings for capital positions and liquidity stable.
Economic shock drives Fitch ratings downgrade
Fitch said the change reflected “expectations of a significant economic shock in the first half of 2020 due to measures taken halt the spread of the coronavirus, followed by a moderate recovery through 2021.”
The downgrade mainly relates the outlook on the operating environment score for the banks, which has moved to negative from stable.
Fitch said it expected GDP to shrink in both Australia and New Zealand in the first half of 2020 with only a modest recovery starting in the second half and extending into 2021.
Unemployment set to jump
Unemployment is likely to spike sharply and remain very elevated relative to pre-pandemic levels even after the recovery is underway.
“The current operating environment scores incorporate this base case and the outlook on this factor would likely be revised to stable should the baseline case scenario eventuate,” the agency said.
“Conversely, a significant extension of the downturn into the second half of 2020, or only a shallow recovery that results in much weaker economic conditions through 2021 and beyond could result in a reduction of the score in both markets.”
Capital and liquidity remain strong
Fitch emphasised that the capital and liquidity positions of the banks remained stable.
“Buffers built in recent years should be sufficient at current scores under our baseline case,” Fitch said.
“We have retained a stable outlook for this factor. Funding and liquidity is supported by sound liquidity management and the significant support provided by the Australian and New Zealand central banks, with limited short-term pressure likely.
“The outlook for this factor remains stable as a result.”
Fitch said it expected that the banks would now maintain stronger financial profiles – particularly for key financial metrics.
“We expect these conditions to affect asset quality and earnings in particular,” it said.
“Support measures implemented by the government, regulators and banks themselves should alleviate some of the asset-quality pressure that will emerge from this downturn, particularly within the next six to 12 months.”