Bank on banks
I'm including the 30 per cent tax break from franking, which all shareholders get to keep.
No wonder the smart money is quitting term deposits as soon as they mature and heading for bank shares.
In giving up a government- guaranteed term deposit, the gamble is that the superior returns from the dividends won't be undermined by a falling share price at some point.
Mind you, if this goes on for much longer it'll be self-defeating, because the banks would then have to pay savers more and term deposits would have the last laugh.
Having thrown off the shackles of following Reserve Bank rate cuts, their dividends have become almost indestructible, which should protect their share price as well.
Yet lending, the bread and butter of banking, is subdued to say the least.
Funnily enough this feeds on itself; the more they make, and the less they lend, the more there is left. It's a magic pudding for shareholders.
But hang on. How can banks make more when their basic business is going nowhere?
Because they've been slashing their staff numbers, or "enhancing productivity" as they put it.
On top of that, their funding costs - what they pay depositors and bondholders for the money they lend - are falling.
Heck, if the banks can pay higher dividends in tough times, imagine what the good times would bring.
Still, you'd think there'd be a limit to growing by shrinking.
Apparently not.
The trick is their dividend re-investment schemes. Typically about one third of shareholders take their dividend in new shares, so the money returns to the bank, or rather never leaves it.
It's a virtuous circle saving the banks a fortune in cash, though pumping out more shares is hardly in the long-term interest of shareholders, not that there's been much sacrifice of late.
But issuing more shares year in and year out must eventually depress the price or at best put a cap on any rise.
At least the Commonwealth Bank has used its latest profit - a record, naturally - to break ranks by buying the shares on market and handing them over.
That's like half a buyback, except the shares aren't cancelled. At least that way there's some buying pressure helping the share price. Incidentally, a point that tends to be overlooked about the banks' profits is they're the biggest borrowers of all.
As a consequence, their immense businesses are based on very little capital when you consider their size.
The reason they're not considered risky is they can boast a lender of last resort in the Reserve Bank, particularly handy in a credit crunch.
Really, unless they put a foot wrong - through bad debts or with a poor acquisition, to which they're unfortunately prone, especially if it's overseas - they're safe as, well, a bank.
That said, more retrenchments, from other employers as well as the banks themselves, would cause more mortgage defaults. And did I mention rising unemployment is exactly what economists are forecasting for this year? But then rates on term deposits would drop, too.
Besides, the banks have enough capital for their dividends to be safe for a long while yet.
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Frequently Asked Questions about this Article…
The article notes many investors are switching because typical term deposits are paying around 4% while bank shares are yielding more than 7% when you include the 30% franking tax break. That higher after‑tax income makes bank dividends look more attractive than government‑guaranteed term deposits for some investors.
According to the article, banks' dividends have become 'almost indestructible' and they currently have enough capital for dividends to be safe for a long while. However, the piece cautions dividends could be threatened if banks make major mistakes (bad debts or poor acquisitions) or if wider retrenchments and rising unemployment cause more mortgage defaults.
The article explains banks are boosting profits and dividends by cutting staff (improving productivity), benefiting from falling funding costs (what they pay depositors and bondholders), and keeping cash through dividend reinvestment schemes. Less lending plus these cost and funding improvements leaves more profit available to pay dividends.
The article says roughly one third of shareholders typically take dividends as new shares via DRPs. That means the cash never leaves the bank, saving the bank money. For shareholders, DRPs dilute existing holdings over time because more shares are issued, which can limit share‑price upside in the long term.
The article highlights Commonwealth Bank used record profits to buy shares on the market and hand them over, which the author calls 'like half a buyback' because the shares aren’t cancelled. Buying shares on market can create some price support, whereas issuing more shares through DRPs can cap future price rises.
The article points out banks are large borrowers themselves and operate with relatively little capital for their size, but they're viewed as less risky because they can rely on the Reserve Bank as 'lender of last resort' in a credit crunch, reducing the chance of collapse unless they make big mistakes.
Per the article, key risks include bad debts, poor acquisitions (especially overseas deals), and a rise in unemployment that leads to more mortgage defaults. Wider retrenchments across the economy could also increase default rates and pressure bank profits and dividends.
The article suggests that if banks keep paying high dividends for too long it could be self‑defeating: banks might eventually need to pay savers more, making term deposits competitive again. It also notes that economic weakness and rising unemployment could affect both mortgage defaults and deposit rates, so conditions can change.
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