The big four banks should be able to maintain their high dividends amid a weaker economy, but would likely need to cut payouts if Australia falls into recession, according to UBS.
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Until recently, the banks have been rewarded by shareholders for their commitment to boosting payout ratios, but as capital requirements for banks increase and bad debts rise, investors are questioning their ability to maintain those ratios, UBS analyst Jonathan Mott said.
The recent sell-off has made bank shares look positively cheap, with dividend yields of 6.3 per cent, Mr Mott said in a research note. The banking sector has fallen 19 per cent from its April high, when the S&P/ASX 200 index reached almost 6000.
The banks could manage rising bad and doubtful debts (BDD), and there was no threshold of lending losses, under which banks would have to slash their dividends, he said.
"In the event the banks are facing higher levels of arrears and BDD charges we expect they would react by both repricing their books [changing their interest rates] and undertaking cost out initiatives," he said.
"The degree to which these levers are pulled will be a function of the extent of the downturn."
Testing scenarios
Mr Mott ran the ruler over several economic scenarios to test the banks' ability to maintain those yields, including a weaker economy, a moderate recession and a China-led hard landing.
The banks could withstand a weakening economy and even emerge looking attractive to investors, Mr Mott said.
"We believe that Australian banks could withstand a weak economy or a shallow recession without needing to cut dividends, with the possible exception of ANZ, depending on the outlook for Asia," he said.
Signs of a weaker economy emerged on Wednesday as Australia's GDP growth slowed to 0.2 per cent, lower than analyst expectations of 0.4 per cent, and the weakest growth since March 2013.
In a moderate recession, where Australia would experience two to three quarters or negative growth and the Reserve Bank of Australia would cut interest rates by 1 per cent, it was likely all the banks would slice their dividends to bring yield to between 4.5 per cent to 5.2 per cent amid sharp falls in their share prices.
"In this scenario we estimate [net profit after tax] and [earnings per share] would fall by 15 to 20 per cent at CBA, NAB and WBC, and by around 30 per cent at ANZ. "
In the hard landing scenario, where the RBA response would be to take interest rates towards zero and initiative quantitative easing measures, Mr Mott's advice was straightforward: "Avoid the banking sector".
