Michael Pascoe: Bank yields remain rich before housing turns


Two bank results down with another to go on Monday and the world has not come to an end – bank dividend yields remain ridiculously rich for income-focussed investors.

And that’s before taking into account the possibility that the fall in housing prices is moderating. More about that a little later.

As reported in this space a month ago, the market has been pricing the Big Four bank shares either for disaster, or as one of the great buys of the year.

The market has been betting that NAB and Westpac would have to cut their dividends and that all of the Big Four faced low growth prospects and significant costs.

With the ANZ reporting its interim result on Wednesday and NAB on Thursday, the market betting has proven correct. We find out about Westpac on Monday, but because the results so far had been anticipated, the pain has been minor.

Indeed, ANZ shares bounced higher on Wednesday and NAB shares fell less than the other banks on Thursday, finishing at $25.70 – 59 cents higher than when we were canvassing the possibilities last month.

Morgan Stanley’s prediction that the NAB would cut its interim dividend by 16 cents a share to 83 cents proved accurate. Assuming the same thing happens with the final dividend, as Morgan Stanley also predicts, NAB will be offering an annual dividend of $1.66. That will carry franking credits of 71 cents, giving an effective pre-tax dividend of $2.37, meaning a pre-tax yield of 9.22 per cent on Thursday’s closing price.

In a low-inflation and lower-interest rate environment, that’s remains very rich for income-focussed investors.

Such a high yield means the market remains cautious about the NAB’s outlook. It’s possible that the bank’s profit could fall further and it would have to cut its dividend further – but that’s not indicated by what the bank was saying this week and doesn’t countenance the upside possibility that the worst of the housing price correction is over.

Of crucial importance, NAB says barely 1 per cent of its mortgage customers are suffering negative equity on their loans. (Negative equity occurs when someone owes more on their property than the property is worth.)

And only 3 per cent of NAB customers have loan-to-valuation ratios of more than 90 per cent. That means that even if housing prices continue to fall further, the negative-equity pain will be manageable.

ANZ kept its dividend steady but the market wasn’t so keen on the bank’s flat profit performance. Nonetheless, ANZ shares closed at $27.20 on the eve of its results announcement, jumped to $27.95 on Wednesday and fell back to finish at $27.27 on Thursday. Go figure.

If ANZ maintains its full year dividend of $2.29, that will represent a pre-tax yield with franking credits of 8.4 per cent. Also none too shabby.

(As the Morgan Stanley analysts were right in their NAB dividend prediction, it’s fair to report that they have a price target of $25.30 for ANZ.)

Meanwhile, there are some green shoots of hope for the main housing markets of Sydney and Melbourne. Average prices are still falling, but the rate of fall is easing. Yes, at some point, prices will find stability.

AMP’s chief economist, Shane Oliver, has been bearish about housing prices, believing they would end up with a top-to-bottom decline of 20 per cent with the bottom not being reached until next year. However, Dr Oliver also predicts the Reserve Bank is about to cut interest rates and now thinks a rate cut on Tuesday could mean the bottom would be reached this year.

And here’s the thing about the money market’s interest rate expectations: two RBA official cuts of 25 points have already been priced in. Banks’ funding costs have dropped, enabling plenty of mortgage rate discounting.

When banks don’t pass on all of an official interest rate cut, there’s a predictable allegation from politicians and anyone with a megaphone that banks’ parents weren’t married. Nobody much notices though when banks make out-of-cycle rate cuts, which is what is happening now.

Yes, banks have tightened their credit standards in light of the banking royal commission and now require much more detail about applicants’ expenses, but they also increasingly want to lend money if they can. That’s what makes them rich and keeps dividends flowing.

The authorities are now on the side of pushing for more lending. Investors’ interest-only (IO) loans that the Australian Prudential Regulation Authority took a big stick to are now back in favour. IO loan rates in particular are being reduced by the banks.

(For a while last year, the idea of a fearsome “IO cliff” took hold in some parts of the commentariat. The idea was that a wall of IO loans were about to fall due and would be forced to become principle-and-interest loans, which would mean substantially higher monthly repayments. The scaremongers failed to account for the authorities’ ability to see the danger and investors and banks being able to manage their risks. The cliff has turned into a mere speed bump.)

Anecdotally, even when banks have been difficult, mortgage brokers have been able to find ways through the credit maze for decent clients.

So, if credit becomes more available, it’s possible that another popular fear – a unit supply overhang – will be more manageable.

We’re not out of the woods yet, but it is indeed possible that the worst is over. I’ve argued elsewhere in The New Daily that the housing market is actually returning to something more normal and healthy after getting wildly carried away with itself.

Auction clearance rates are down – so what? Some 85 per cent of Australian housing is sold by private treaty. Auctions are great when a market is running hot and there are plenty of buyers competing for the same property, but their worth is debatable when the market is sane.

If the falling-house-prices bogey is tamed, the potential upside for banks (and the economy overall) improves. It’s a matter of time.