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Ideas for Australian banks' A$33B cash stash: buybacks, dividend

Australia's big four banks, sitting on more than A$33 billion of excess capital over regulatory requirements, may announce more share buybacks and step up dividends, analysts say.

Australia and New Zealand Banking Group Ltd., or ANZ, kicked off a potential investor windfall after it announced on July 19 that it plans to buy back up to A$1.5 billion of shares as part of its capital management plan. Investors' focus will now shift to Commonwealth Bank of Australia, or CBA, National Australia Bank Ltd., or NAB, and Westpac Banking Corp. on what they will do with their surplus capital that accumulated as the major banks cut dividends in 2020, became more conservative in lending, and sold noncore assets.

"We expect the big four to progressively announce multibillion dollar buybacks over the balance of 2021 and into 2022," said Toby Grimm, a portfolio manager at Baker Young, an independent private stockbroking company.

With average Tier 1 capital ratios around 12.5%, well above the 10.5% mandated by the Australian Prudential Regulation Authority, and arguably eased regulatory pressure, "it is entirely plausible that over the next 12 months all four majors announce buybacks," Grimm said, adding that he expects Commonwealth Bank and ANZ to conduct the largest repurchase in dollar terms and on a size-adjusted basis, respectively.

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According to S&P Global Market Intelligence calculations, CBA has A$9.5 billion of surplus capital above the mandatory requirement as on March 31, 2021. The corresponding surpluses at ANZ and Westpac are A$7.9 billion each, while NAB has A$7.8 billion in excess capital, Market Intelligence data show.

Temporary drag

A recent resurgence in COVID-19 cases and lockdowns in parts of the country may not force a rethink, as most economists and analysts expect the effects of the virus outbreak on the economy and bank earnings to only be temporary. Australia's major banks have reinstated loan deferrals to support customers affected by lockdowns in several parts of the country.

Even with the uncertainty, banks still have the capacity to return capital to shareholders despite the current lockdowns as Australia moves to contain the spread of the disease, said Omkar Joshi, principal and portfolio manager at Opal Capital. "We saw last year that the banks emerged from the lockdowns in quite strong positions so at this point it doesn't seem to be a major concern," Joshi said in an email to S&P Global Market Intelligence.

"The current lockdowns might change the timing, but we still think the [buybacks] are very likely over the next few years. The banks are already very well provisioned for loan losses," said Nathan Zaia, an equity analyst at Morningstar.

Even if the banks keep a buffer and bring down their common equity Tier 1 ratios to about 11%, they have a capital surplus of about A$25 billion, Zaia wrote in a June 25 research note. CBA can make a buyback of around A$5.5 billion, or around 3.5% shares on issue, NAB will look to return capital with a buyback of around A$2.9 billion, while Westpac may buy back around A$5 billion of shares, Zaia said in the report.

Strong capital position

Banks have already resumed regular dividend payments, often an important source of income for Australia's retail shareholders, especially retirees. CBA in February announced a dividend of A$1.50 per share for its fiscal first half, a 53% increase over the 98 Australian cents per share paid in the previous six-month period. The biggest Australian bank by assets also reiterated its long-term dividend guidance. All Australian banks had slashed payouts last year after the Australian Prudential Regulation Authority in April 2020 asked them to consider deferring dividend decisions.

A CBA spokesperson told Market Intelligence that the bank has a strong surplus position that creates flexibility for capital management initiatives. "The timing and extent of any such initiatives is dependent upon a continued trend of domestic economic improvement, our ongoing assessment of portfolio credit quality and regulatory guidance," the spokesperson said. Westpac declined to comment.

ANZ said its plan to conduct an on-market share buyback is "the most prudent, fairest and flexible method to return capital in the current environment." ANZ said its reported level 2 and level 1 CET1 capital ratios as on March 31 were 12.4% and 12.2%, respectively. The buyback is expected to reduce ANZ's CET1 ratio by about 35 basis points from the March 2021 level.

The banks are unlikely to use the excess capital for large acquisitions after they sought to streamline their businesses and sharpened focus on their core banking operations in recent years, analysts said. The big four have largely unwound their wealth management businesses and exited insurance. Regulatory pressure following the release of the Banking Royal Commission report in 2019 that exposed misconduct and violations of consumer rights has made banks simplify their operations and focus on their core business of lending.

Banks can also generate enough organic capital for any future growth investments. Although banks face competition from nonbank entities and would need to invest in technology, they may deploy a part of their excess reserves towards such investments, said Baker Young's Grimm.

Martin North, principal at Digital Finance Analytics, said the big four should use the cash to invest in upgrading their technology. The banks "should be focusing on process improvement and digitization and still have high margins due to weak competition," he said.