Westpac Banking Corp (ASX: WBC) is the talk of the town this week, following its decision to raise $3.5 billion in new capital from shareholders and increase its interest rates on variable rate and investment mortgages.
To raise the huge amount of money, Westpac is offering all shareholders the chance to buy 1 new share for every 23 they currently own, at $25.50 per share.
The benefits for Westpac are obvious. The bank can collect the $3.5 billion and put it towards its Common Equity Tier 1 ratio, known as CET1. This is the regulator's required cash buffer against market crashes and shocks. A recent announcement by APRA, the banking regulator, suggests the CET1 ratio of all major banks will soon be required to be within the top quartile of banks globally.
One of the negatives from Westpac's move to raise capital is that more shares will trade on the market. That means any time the bank declares a dividend of X-amount of dollars per share, for example, it'll be required to pay more money to investors because more shares are in circulation.
All else being equal, profits per share will fall because its profits are spread over more shares. Going one step further, some investors have become concerned that the bank may not be able to afford to keep paying its increasing dividends while meeting regulatory changes and growing competition.
However, on an analyst conference call, Westpac CEO Brian Hartzer said the bank intends to pay its final 94 cent dividend to shareholders. "We are sticking with our current dividend approach of seeking to steadily increase dividends, within the context of a sustainable payout ratio", he said.
The final dividend will not apply to any of the new shares issued under the $3.5 billion capital raising, so essentially Westpac has bought itself some time.
Indeed, it can keep dividends high in the next six months, appealing to income and SMSF investors alike; while also meeting its capital requirements.
And by the time it's required to pay next year's dividend, its decision to gouge property investors and homeowners should begin to trickle through to higher profit. However, a major risk to Westpac's strategy could be found within its key rivals, since they may not follow with interest rate increases on mortgages.
For example, if Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) refuse to increase their mortgage interest rates, customers will likely jump ship to cheaper alternatives.
Cyclical bad debt charges are also a risk to the bank's dividend over the medium term. However, so long as Westpac maintains its profit margins, its current dividend appears sustainable – although nothing is guaranteed.
Foolish takeaway
In my opinion, Westpac's dividend appears sustainable for now. However, I'm going to keep a close watch on the bank's net interest margin, bad debt charges, growth in average interest earning assets, cost-to-income ratio and return on assets. A significant change in any of these metrics could be a reason to become concerned about the sustainability of the bank's dividend.
However, despite my belief that the dividend looks sustainable, for now; I'm not a buyer of Westpac shares at today's prices.
