Dividends for big fours still attractive

Despite the headwinds, dividends still remain attractive for the big four banks, according to Martin Currie Australia, part of Franklin Templeton.

Reece Birtles, chief investment officer, Martin Currie, said he was comfortable with retaining bank exposures for their income generating ability, however, the focus on downside income risk would mean that this was at a significant underweight relative to a yield-weighted view of the index.

“Investors seeking an income stream that is resilient to macroeconomic volatility should be cautious of protecting against downside income risk,” he noted.

“Saying this, our proprietary estimates of the resilience of dividends for the big four banks remain attractive, and largely in keeping with broker consensus forecasts for franked dividend yields for the next twelve months.”

Based on the Martin Currie’s analysis, which looked at the entire sector as well as the impact of changing funding costs and margins on bank earnings and prospective dividends, the manager adjusted its forward expectations for each bank’s relative valuation and re-evaluated its proprietary assessments of their ability to sustainably pay dividends at current levels.

“Traditionally, the big four banks’ share prices and active returns have shown a strong co-movement with each other. Residual differences in ratings or valuations between the banks should then be justifiable through differences in return metrics like return on risk-weighted assets (RORWA) or earnings growth,” Bristle said.

“Over the last decade, there has been a meaningful decoupling of Commonwealth Bank of Australia’s (CBA) total shareholder return from its peer group, primarily due to its higher trading multiple. There is far more modest evidence, however, of CBA delivering sustainably differentiated operating metrics compared to the other big four. To us, it is difficult to make the case that a valuation difference is truly supported for CBA.”

The analysis demonstrated that with deposit margins now a headwind, the only realistic method for banks to repair their net interest margins (NIMs) will be by limiting the pass-on benefits to customers when a rate-cutting cycle commences.

According to Birtles, lower savings are likely to reduce customer demand for credit.

“If the outlook for bank margins appears challenged, are there opportunities for offsetting growth in credit to compensate? Our approach also used proprietary analysis of household income data to include an assessment of credit serviceability from a system-wide perspective, and house price forecast scenarios,” he said.

Also,  Birtles noted that bank earnings risks remained skewed to the downside, and CBA in particular appeared overvalued.

He said that for portfolios focused on total return, he believed that inferior NIMs and rising potential loan losses would support underweighting the banks sector vs. the S&P/ASX 200 Index.