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Westpac dividend tipped to fall

Emma Rapaport  |  02 Oct 2019Text size  Decrease  Increase  |  
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Morningstar equity analyst Nathan Zaia has warned that uncertainty over future capital requirements could force Westpac Banking Corporation to lower its dividend.

Zaia suggests the dividend could fall by as much as 12 per cent due to uncertainty surrounding the bank's future capital requirements in New Zealand. Other reasons include:

  • additional Westpac customer remediation costs linked to the banking royal commission; and
  • a desire to avoid suppressing loan growth unnecessarily.

"When Westpac reported first-half earnings in May, the bank appeared in good shape to meet the Australian Prudential Regulation Authority’s 10.5 per cent unquestionably strong target by January 2020.

"However, we estimate capital headwinds, new and previously known, will detract around 44 basis points from Westpac’s common equity Tier 1 ratio by December 2019," Zaia says.

Morningstar's $31 fair value estimate for Westpac (ASX: WBC) remains, but after a review of earnings forecasts and capital position, Zaia no longer expects Westpac to hold dividends flat at $1.88 over the medium-term.

Zaia has reduced his fiscal 2020 dividend forecast to $1.65 – down 12 per cent – implying a dividend payout ratio of 76 per cent. He says Westpac still trades on a relatively attractive fully franked fiscal 2020 dividend yield of 5.5 per cent.

Higher operational risks are one of the major capital risks for Australian banks. In July 2019, APRA announced the major banks would each hold an additional $500 million in capital until they have resolved poor governance issues. This applied to all majors except Commonwealth Bank, which had been slapped with a $1 billion capital add-on in May 2018.

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Zaia says this capital burden will remain in place until the banks have demonstrated completion of planned remediation to strengthened risk management.

He expects Westpac to maintain its final dividend, but anticipates capital to fall below 10.5 per cent after the final dividend is paid in December 2019. To offset this, Zaia believes Westpac will partially underwrite the dividend reinvestment plan (DRP).

DRP's give shareholders the option to take dividends in the form of additional shares rather than cash. As companies don't know how many shareholders will participate, they can arrange to have their DRP's underwritten to guarantee a certain amount from the underwriter. This strategy is typically employed by companies with a significant need to guarantee capital.

Zaia says underwriting DRP is a relatively low-risk near-term measure to support the capital base. He points out that National Australia Bank took a similar step in May 2019. However, he says longer-term Westpac needs a more sustainable solution to its capital requirements.

Cut 'for the best'

Zaia says the bank is aware of the reliance and value shareholders place on dividends, particularly with the Reserve Bank of Australia cutting the cash rate to a new record low of 0.75 per cent, and the board suggesting they are prepared to go even lower if the nation's economy doesn't respond.

However, he believes Westpac's board will have to take the tough decision on its payout ratio "sooner rather than later" and that the flexibility and headroom provided from a lower dividend is sensible.

"With a target dividend payout ratio of 70 per cent to 75 per cent, Westpac has taken a shareholder-friendly approach of holding the dividend flat for the past three years by letting the payout ratio rise to an average of 80 per cent," he says.

"We, like Westpac, assumed earnings growth would eventually bring the payout ratio back to a more sustainable level without a dividend cut. 

"Regulatory change, the royal commission, and slower economic growth have all helped derail that thesis."

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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