Westpac: Special dividends ahead?

Westpac’s strong capital build was the highlight of the annual profit result causing shareholders to hope that the bank might break from the pack and pay them higher dividends.

On Monday, Australia's largest lender posted cash earnings of $8.06 billion for 2017. 

A rapid increase in Westpac’s core equity tier one capital ratio means the bank has now reached "unquestionably strong" levels of 10.56 per cent.

This is a 59 basis point rise on the 9.97 per cent achieved in the 2017 first half.

Although Westpac is still awaiting the finalisation of mortgage risk weights, its period of capital build looks largely complete, according to UBS analyst Jonathan Mott.

Special dividend

“While capital is likely to be accumulated for the next half to provide more flexibility around the finalisation of Basel 3, we expect Westpac to begin to increase capital returns," he said in a client note.  

“Westpac should have more clarity in coming months as APRA finalises this process during this calendar year.”

With limited growth prospects, Mott is expecting Westpac to return some of this excess capital to shareholders by upping the ordinary dividend, paying special dividends and neutralising the shares issued through the lender’s dividend reinvestment plan.

The analyst expects the ordinary dividend to be increased by 1 cent per share, each half - starting in the 2018 first half - with the special dividend of 10 cents per share to be paid with each final dividend for the next three years.

However, according to Mott, this scenario of higher capital returns is predicated on a number of things happening.

Healthy economy

Because the growth outlook for Westpac remains subdued, this capital return profile is based on the economic outlook remaining healthy.

“Credit growth needs to remain subdued, in the low single digit range.

"Net interest margin needs to slowly erode with lower funding costs partially offsetting lending pressure.

"Cost efficiencies need to be delivered. Unemployment and interest rates need to remain low."“

Tellingly, Mott expects the majority of shareholder returns to come from dividends.

Mott’s forecasts - which have built in these capital returns - are also predicated on a stable political environment, given the opposition's policies include: reducing negative gearing, capital gains tax relief & trust tax shelters; higher tax rates for high income earners; and a Bank Royal Commission.

Disagreement over capital return options

The analyst is forecasting a cash profit of $8.16 billion for 2018, $8.21 billion in 2019 rising to $8.35 billion in 2020.

Meantime, Morgan Stanley analysts consider Westpac has limited capital management options even though the bank’s CET1 ratio will likely increase to 10.8 per cent at the 2018 first half.

They think Westpac can neutralise the next DRP but, as they see it, additional capital management initiatives and/or dividend growth looks unlikely in 2018.

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