Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) are facing higher interest rates.
Big Four Bank Dividends
As can be seen in the chart above, even at today's elevated prices, shares in Australia's big banks are yielding hefty dividends, with full franking.
Will rising interest rates destroy ASX bank dividends?
If you have been tuning into financial markets or reading the business section of a newspaper in recent weeks you would have noticed that there has been a lot of talk of rising interest rates.
Not so much here in Australia, but in the United States. The Federal Reserve increased interest rates earlier this month and flagged three additional increases in 2017.
With NAB recently raising interest rates for both homeowners and property investors we have already seen the effects of this directly flowing through to households.
But what about shareholders? Do higher interest rates affect dividends?
In the first instance, the answer is probably not. At least, not in the short term — your dividends should be fine.
How rates affect bank dividends
Higher interest rates are often good for banks. You might be thinking that much is obvious.
You are probably thinking that much is obvious.
But what we are actually seeing is US — not Australian — interest rates on the rise. For banks like ANZ, Westpac and its peers, that's usually bad news because a lot of the money they lend to households comes from US debt markets. Therefore, higher interest rates in the US mean they have higher funding costs. Hypothetically, if just one of them raised interest rates like NAB did, but their competitors did not follow suit, then they would be less competitive and potentially lose market share.
Fortunately, all of the Aussie banks are being affected, so higher funding costs will be an industry thing and not specific to just one bank.
The kicker for banks
The best thing about rising interest rates for banks is that their profit margins widen. Look for the Net Interest Margin (NIM) in a bank report.
Bank funding costs (think: term deposits and wholesale debt markets) are usually shorter-term funds whereas their 'assets' (think: mortgages, personal loans, etc.) are longer-term. If you have ever looked at an 'online mortgage calculator' you would have noticed that the longer the loan's duration the more interest they collect. Bank's exploit the difference between the short and long run interest rates.
The effect on dividends
Ultimately, as noted above, rising interest rates are good news for bank shareholders because profit margins should expand and increase (yep, you guessed it) profits.
That's the short-run effect.
Longer-term, it's a balancing act for the banks, as always. That's because when interest rates rise over long periods, a bank's lending standards are most important thing to consider.
For example, if a bank has lent $1.2 million on a $800k house (probably valued by the estate agent) to a couple, with eight kids and one income, you know how that ends.
Or if a bank has fuelled the operations of an investor with a portfolio of 200 negatively geared boxes in the outer burbs, well…let's not think about that.
But if a bank is a prudent lender of capital, they will do better. For shareholders, the dividends should be sustainable.
There are a few warnings signs:
- Rapidly rising 'assets' on the balance sheet, or as the banks would put it: 'above-system growth'
- Narrowing 'net interest margins'
- Increasing 'delinquencies' or bad debt costs as a percentage of assets
