The more than 3 per cent bounce in Westpac's share price following the release of its flat profit results for 2016 explains why the bank was so tenacious when it comes to rewarding investors by maintaining dividends.
The concern about the potential for a dividend cut was widespread, real and understandable based on the extremely ordinary industry environment. Despite this Westpac's decision to feed the addiction that shareholders have for dividend yield is a clever way to breath new life into the share price – or at least put a floor under it.
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Westpac's condescending rate hike explainer
In 2009, Westpac released a video arguing why it could put up interest rates. Many interpreted it as condescending, leading to a variety of parodies and spoofs taking on the bank's patronising tone.
While shareholders got their fix this time around they should really start to wonder how sustainable this shareholder generosity is beyond the 2016 financial year.
Westpac's chief executive Brian Hartzer is certainly making no promises about 2017's dividend. Nor should he. On Monday his outlook statement suggested in earnings terms, it would be more of the same. He also said that the current dividend payout ratio of 80 per cent is higher than he would like but that in 2016 the balance sheet was strong enough and the bank had plenty of franking credits to retain the dividend.
The reason the dividend absorbed a higher proportion of Westpac's profit is that it issued new capital during the year. More shares equals more dividends to be paid in aggregate.
The bank had to issue more capital because regulatory settings became more stringent so they needed a bigger safety buffer.
The trouble is that they may become more stringent again in 2017 or early in 2018. The banks are just waiting to see how this plays out.
So there is now a risk to the size of future dividends even if Westpac (and the other banks for that matter) retain the current profit levels. Both NAB and the Commonwealth have shied away from cutting dividends in their latest profit reports.
The other effect of having to increase the capital buffer is that the bank's performance when measured by return on that equity is going down. It fell by 1.85 percentage points between 2015 and 2016 to 14 per cent.
Hartzer moved away from a previous 15 per cent target for return in equity and instead is guiding towards 13 to 14 per cent.
This appears to be softening up the market for the potential for those capital buffers to muscle up further. He insists this is not a target but a "realistic range".
Generally there was nothing – other than the dividend – contained in the Westpac profit that was especially positive.
It was a solid result under the circumstances – but the circumstances were not great.
The competition that was a particular feature in 2016 remains hot, Westpac's cost of funds are edging up and its institutional bank business – which deals with very large corporate clients – remains under some structural pressure. BT Financial Group struggled and Westpac's New Zealand earnings were under pressure.
On the positive side the quality of loan book is fairly good and doesn't appear to pose any particular risk and the consumer franchise – clearly the highlight – is chugging along well as is the segment of the bank that services the small and medium sized business customers. Westpac said its consumer bank "continued to build the value of the franchise, with record new customer acquisition and 8 per cent loan growth, contributing to a 14 per cent rise in cash earnings". But it noted that growth slowed in the second half of 2016, in part reflecting the impact of higher funding costs and increased competition.
All in all – the result was pretty much what the analysts were expecting – other than the dividend.
Mr Hartzer said the outlook for Australia remains positive overall, with GDP expected to increase by around 3 per cent in 2017 which will be assisted by the rolling through of the drag created from reduced investment in mining.
"This growth reflects an expected rise in household spending, ongoing contributions from exports, and continuing government investment in infrastructure."
But he described the mechanics of growth in lending as a bit of a Catch 22 – with business having the means and opportunity to borrow to invest but reluctant to do so until there is evidence that consumers will spend more but consumers are waiting for signs their employment fortunes will improve from increased business investment.
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