The price you pay for generous dividends

While the big four banks deliver record payouts, the days of surging profits are over, writes David Potts.

While the big four banks deliver record payouts, the days of surging profits are over, writes David Potts.

Whatever you say about banks, you have to hand it to them for turning a profit in this climate.

Never mind whether they're greedy in not passing on enough rate cuts, or too many in the case of savers, when often as not their customers meekly wear it. Sorry, don't mean you.

But there are some surprisingly generous offers around if you look. The NAB-owned online-only UBank has a one-year fixed rate of 4.79 per cent, almost what it pays savers on a six-month term deposit.

Even its 5.47 per cent variable rate has been trumped by non-bank, with 5.42 per cent - neither with an application fee.

Let's see, the last time rates were that low was in 1968 when Johnny (as he was then) Farnham was singing Sadie the Cleaning Lady and the Pope renewed a ban on contraceptives. Ah, progress.

Where was I? Oh yes, bank shares. The average super fund is stuffed full of them because they pay so well.

There can't be a better, more reliable income than bank dividends returning about 6 per cent, plus a 30 per cent franking credit. That's a good 8 per cent a year before tax.

The banks are giant ATMs that dispense dividends - despite lending, which is what they're all about, barely growing in real terms.

Trouble is lacklustre lending and an average return on equity of 15 per cent don't mix, though the Reserve Bank is engineering a housing recovery next year that is everything a bank could ask for.

While they whinge about an increase in capital required by regulators, banks also regenerate it by self-funding part of their dividends courtesy of shareholders who opt to reinvest rather than take the cash.

Besides, they're sitting on surplus capital having been panicked into raising more than they needed during the GFC.

Higher funding costs? Under control, not that the banks admit it it's just that savers do better, or rather less worse, than borrowers. About the only thing that could go wrong for them is the strong dollar squeezing the economy even harder.

A rise in unemployment would increase bad debts, but the Reserve is on the case.

Even dividends are protected by a nice capital buffer.

Really, it all seems too good to be true for the banks, and it half is.

It's their share price that's the problem. The market value of the best-run bank, the Commonwealth, exceeds its peak in 2007 (from which other stocks still have to claw back an average 50 per cent). The same goes for Westpac. Yet it was a much easier time for banks back then because lending was booming.

So I suspect the trade-off for decent dividends will be a sluggish share price. Still, you could do a lot worse. And probably have.

Follow David Potts on Twitter @moneypotts.

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