Capital returns are the flavour of the month in the banking sector. Westpac (ASX:WBC) announced a fully franked $500m special dividend and added $1bn to its share buyback. National Australia Bank (ASX:NAB) held its interim dividend flat but added $1.5 billion to its buyback. ANZ (ASX:ANZ) announced a further $2 billion in buybacks. Commonwealth Bank (ASX:CBA) didn’t announce anything major this time but continues to repurchase its shares.

These announcements came on the back of fairly good but not excellent bank earnings for the second half of 2023. So where is the money for these buybacks and dividends coming from? And what do our analysts expect for the big four’s dividends and buybacks going forward? Let’s tackle the second question first.

What is Morningstar's outlook for big four bank dividends?

For the past decade, none of the big four banks have set the world alight in terms of dividend increases.

As of their last annual results, Commonwealth Bank has grown its per share dividend by around 2% per year since 2013. NAB was next best with 1% average growth and ANZ’s dividend grew by an average of just 0.6% per year. Meanwhile, Westpac’s annual dividend peaked in 2016 at $1.89 and had fallen to $1.42 in 2023.

Covid-19 was an obvious speedbump – the big four all cut their payouts significantly – but dividend growth was also lackluster in the years leading up to the pandemic. Now for the good news. Morningstar’s banking analyst Nathan Zaia expects that growth to accelerate.

Nathan is most optimistic about Commonwealth Bank and Westpac’s ability to raise dividends. He expects both to record 4% annual dividend growth over the next five years, taking Commonwealth Bank’s per share payout to $5.45 by 2028 and WestPac’s per share dividend to $1.71 by the same point. He expects ANZ and NAB to grow their payouts by 2% per year over the same five-year period.


Here’s why Nathan thinks Commonwealth Bank and Westpac can deliver stronger dividend growth:

“Commonwealth Bank has the most to benefit from a cooling of price competition in mortgages and household deposits. Westpac is expected to deliver stronger earnings growth given more upside from cost savings. Westpac’s surplus capital position could also help it pay out a higher percentage of profits as a dividend. Not only does Westpac still have surplus capital right now, that could increase by another $1.5 billion if AFRA removes additional capital burdens placed on it for operational risks.”

Where will the money come from?

Nathan sees a fairly positive outlook for the big banks. Although he expects loan losses to increase slightly from cyclical lows, he doesn’t expect them to rise back to historical averages in the medium term unless there’s a very severe recession. As a result, Nathan doesn’t expect big bank earnings to be hit by a wave of bad-debt expenses.

This, however, is not where he sees most of the wiggle room for dividend growth. Instead, he sees it coming from the banks continuing to bring their regulatory capital surpluses down to target levels. This was also a major factor in the buybacks announced in 2023’s H2 results.

What is regulatory capital?

Regulatory capital is capital that banks are required to set aside to absorb potential loan losses. The highest quality level of this is common equity tier 1 capital (CET1), which can be comprised of common stock, retained earnings, minority interests and other sources of income.

The Basel III framework for global banks requires lenders to have a minimum common equity tier 1 capital ratio of 4.5% of a bank’s total assets, weighted for how risky those loan books, securities and derivative holdings are. Additional tier 1 in the form of other securities can be added to reach a minimum ratio of 6%, and lower quality tier 2 capital can be added to meet a minimum level of 8% of risk-weighted assets. In Australia, APRA imposes a minimum CET1 requirement of 10.25% on the major banks, but expects each will maintain a capital ratio of at least 11%.

Australia’s major banks are all well above those minimum capital requirements, however, the latest round of capital returns will see these ratios fall slightly.


Are falling tier 1 capital ratios a concern?

Although tier 1 capital ratios get a lot of coverage, Nathan explained that they are actually the last layer of protection against potential loan losses. First you have operating profits, then bad loan provisions, then the regulatory capital.

The big four’s earnings were slightly weaker for H2 2023 against a strong previous half but they are still robust. Bad debt provisions also look plentiful, as the big four built up large reserves through Covid and the post-pandemic years in anticipation of higher default rates. Things have turned out far better than was expected, but the banks have continued to factor a potential downturn into their provisions.

Then you come to the capital positions.

The big four banks are all comfortably above regulatory requirements. Their capital positions compare favorably to other major banks worldwide on a headline basis. But this isn’t the whole picture. APRA’s rules on what Australian banks can declare as tier 1 capital are far stricter than the Basel agreement’s definition. On an apples-to-apples basis, a slide from Westpac’s results presentation claims that Australia’s big four are all in the world’s top seven major banks by tier 1 capital.

Will the buybacks and dividends change this?

Nathan doesn’t think the buybacks change this much. The buybacks sound big in dollar amounts, but they are a small single-digit percentage of shares outstanding and are being funded by a small decrease in surplus capital.

Nathan also views the big four’s general preference for buybacks over dividends as a conservative move. While a dividend goes out of the bank’s coffers straight away, a buyback can always be scaled down if conditions worsen. A lower share count could also help the banks to maintain or increase per-share dividend payments despite softer earnings or a lower payout ratio.

Are lower capital positions a one-time boost for capital returns?

Nathan feels that all four major banks have plenty of room to bring capital ratios down further towards management’s target levels. This could free up more funds to support the dividend and other capital returns – even if the recent trends of rising house prices and low unemployment subside.

Are big bank shares good value?

While Nathan is fairly positive on the outlook for big banks and their dividends, the shares don’t look especially cheap versus his fair value estimates.


Commonwealth Bank currently trades at over a 35% premium to Nathan’s Fair Value estimate. He sees more value in ANZ and Westpac shares at the moment. But even those trade only modestly below his fair value estimate.

For more from Nathan on the recently round of big bank earnings: