Dividends run ahead of bank profits

Australia's biggest banks, which have already elevated their dividend payout ratios, are now offering dividend payouts that run well ahead of their operating business.

As the biggest players in the “yield” business Australian banks have been in the spotlight in the latest reporting season which saw ANZ, NAB and Westpac report full-year results in recent days.

Industry analysts have noted that dividend growth in the latest reporting season was running ahead of profit growth.

Dividend growth among the banks – majors and juniors – is now running at 13% with total dividends at $23 billion. Meanwhile, cash profits increased 9%, figures from the Australian Bankers' Association show.

Most major banks' payout ratios held broadly steady at around 75% this reporting season, meaning the jump in dividends comes as banks pay out a steady share of a larger pool of earnings.

ANZ's dividend payout ratio (in terms of cash earnings) edged down 50 basis points to 68.9%, CBA's fell 30 basis points to 75.1% and Westpac's dropped 230 basis points to 74.2%, a report on the bank results from Ernst and Young shows. NAB was an exception, with its dividend payout ratio rising 1,250 basis points to 90.1%, given the writedowns the lender booked in its troubled UK division.

A spokesperson for the Ernst and Young research team behind the report says whether or not dividend payout ratios will be able to remain steady in future is “the $64 million question”, adding that it will depend on the extent to which banks can grow capital and the amount of extra capital they could be required to hold as a result of the Financial System Inquiry.

Credit growth lags

Indeed, if profit growth lagged dividend growth then lending growth – the engine room of bank returns – fell way behind.

For the four major banks, total cash profits rose 5.7%, EY said. Meanwhile, total growth in credit over the year to September was 5.4%, a PricewaterhouseCoopers report found.

PwC points out that this is the strongest credit growth since February 2009, when the GFC began to weigh on demand.

But the rise lags behind the pace of increase in cash profits. PwC says one reason for this is the reduction in bad debt expenses, which fell from $5 billion last year to $3.5 billion this year. The firm says the fall contributed to 65% of the overall improvement in earnings before tax.

But PwC warns the bad debt expense to loans ratio is at the lowest point since the mid-1990s.

"While this is good news, bad debt expenses reflect the risks of the past. It's hard to see bad debt expenses continuing to fall,” PwC Australia's financial services leader Hugh Harley said in a statement.

Cost pressure remains

Operating costs are rising overall, PwC found, up 9.7% or $3.2 billion this year. But the firm blamed NAB's writedowns for more than half of the total increase. Other cost increases were due to above-inflation salary increases and a lift in IT costs.

But at a more granular level, the picture on costs looks different. EY found the cost to income ratio reduced marginally in 2014. Among the majors, EY said the cost to income ratio on a statutory basis fell slightly at ANZ and CBA, held steady at Westpac and jumped at NAB.

The net interest margin, which measures the success of returns compared to debt expenses, fell slightly this year. EY said that across the majors, the net interest margin has fallen by 5 basis points to 2.07% due to pressure on loan margins and increased holding of liquid assets.

“Housing loan margins remain under pressure, as the banks pursue growth through competitive pricing,” the EY report said. “Business lending, which typically returns higher margins, remains somewhat subdued, offering an area of potential growth for the banks.”

The future performance of Australia's banks will depend on the broader economic outlook, EY says.

“They are inherently exposed to the performance of the Australian economy, which seems to be growing at a reasonable, not exceptional rate,” the EY spokesperson said.

“If GDP growth or employment growth slow or accelerate that has a positive or negative effect on banks. The bad debts in the current environment are relatively benign because the economy is relatively stable.

“The key challenges to the banks are the very rapid changing consumer behaviours, particularly around digital. That has been quite a transformational change in the way people interact with their banks which they need to continue to adapt to.”