How ASB's parent CBA and the ANZ Group could maintain dividends even in a 1-in-30 year GDP 'shock scenario'

By Gareth Vaughan

Analysis by Citigroup suggests two of Australasia's big four banks, ASB's parent Commonwealth Bank of Australia (CBA) and the ANZ Banking Group which owns New Zealand's ANZ and National banks, could maintain their dividend payouts even in a one-in-30 year Gross Domestic Product (GDP) "shock" scenario.

In a report entitled Stress testing bank dividends: ANZ and CBA get a pass mark, Melbourne-based Citi analysts Craig Williams, Wes Nason and Andrew Minton said CBA and ANZ could sustain their dividends even if GDP fell 7%, which would be a hit similar to the recession of the early 1990s. However, they said BNZ's parent National Australia Bank (NAB) fell short of their stress test hurdles and the Westpac Group performed "by far the worst" in their stress testing of the big four Australasian banks.

The analysts said it would take a shock the magnitude of a 7% GDP drop for the big four banks to breach minimum stressed capital requirements and make cuts to dividends. However, the four are in a better position than in the 2008-09 slowdown or the early 1990s recession (when many banks cut dividends and raised capital and the BNZ got bailed out with NZ$620 million of taxpayers' money) due to significantly higher levels of capital, a weak credit growth environment, and "well seasoned" business lending portfolios following four years of deleveraging. They say average capital across the four banks is 8% now versus 5.5% in 2007 and credit is growing at about 4% now versus 15% five years ago.

The analysts say the relatively weak credit growth and higher initial capital positions are the main reasons why ANZ and CBA are able to withstand such a shock.

"ANZ's much higher starting capital, surprising level of improvement in credit quality, and lower dividend payout ratio see it perform best in our stress test," Williams, Nason and Minton say.

ANZ paid a fully franked 2012 interim dividend of A66 cents per ordinary share on July 2, equivalent to 60.8% of profit (versus 68.5% in the last annual results). CBA paid a A$1.37 per share interim dividend, equivalent to 61% of profit, compared with the 78.3% profit payout ratio in its last annual results.

NAB's 'higher risk lending book' & Westpac's 'predominantly sub investment grade corporate credit'

NAB comes up short in the stress test due to a higher risk lending book. Westpac's "predominantly sub investment grade" corporate credit portfolio and large specialised lending portfolios acquired through its St George Bank acquisition in 2008, contribute to it also coming up short.

NAB's Core Equity Tier 1 capital ratio (CET1) fell to 6.9% in the stress test, below the Citi imposed 7.5% floor, with the analysts saying the drop is driven primarily by "significantly lower" asset quality than peers.

"This implies a A$2.3 billion capital raising to maintain dividends," the analysts say.

NAB's half-year dividend was A90c per share, up from A88c a share in the second-half of the previous financial year.

Meanwhile, Westpac's CET1 drops even lower, to 6.5% in the stress test.

The analysts said Westpac now had "much lower" corporate/business asset quality than is generally understood, mainly due to its St George acquisition.

"Hypothetically our stress test implies a capital raising of A$3.6 billion for (Westpac) dividends to remain untouched."

In its interim results Westpac disclosed an A82c per share dividend, up 3% from A80c in the second-half of the previous financial year, making it the bank's highest half-year dividend ever paid. Westpac's first half-year payout ratio was 78.4% of profit, or 65% given about 17% of dividends return to the Group via a dividend reinvestment plan. Westpac paid out 67% of profit in its last full-year.

The Citi stress test scenario applied a more severe GDP contraction than seen in 2007-09, and assumed significantly less support from both the Australian Government, via economic stimulus, and from the Reserve Bank of Australia, through Official Cash Rate cuts.

"We take our existing earnings forecasts, adjust credit growth, ramp up bad and doubtful debt charges, though make little change to margins, as in previous sharp downturns margins have been maintained because of the minimal requirements to fund balance sheet growth," the analysts say. See further detail in their charts below.

Meanwhile, the analysts note the bank sector's forward dividend yield of 7.3% exceeded 10-year Australian Government bonds by "an almost unprecedented margin" of 4.4%.

"We believe this represents a fear spread, rather than relating to real risks around capital sufficiency or dividend sustainability," Citi's Williams, Nason and Minton say.

They also point out that, with the exception of Spanish bank dividends, "where sustainability must be more questionable," the Australasian banks have the highest dividend yields amongst Citi's coverage of developed market banks. This comes after recent analysis from the Bank for International Settlements showed the big four Australasian banks to be the most profitable in the developed world, when measured by pre-tax profit as a percentage of total assets. Interest.co.nz subsequently broke out figures for the New Zealand subsidiaries of the four, showing them to be even more profitable than their parents.

The Citi analysts forecast a full-year dividend yield of 7.6% for both Westpac and NAB, 6.6% for ANZ, and 6.1% for CBA.

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