The Westpac Banking Corp (ASX: WBC) share price edged higher this afternoon, despite the bank warning that the federal government's new 6 basis points levy on some of its liabilities could lead to dividend cuts.
Cutting dividends is a sacrilegious act for bank investors, yet Westpac this morning warned that the assessed $260 million cost of the levy would have shaved around 8 cents per share off last year's full year dividend payout of 188 cents per share.
The government's levy is essentially a quid pro quo in exchange for the liquidity guarantee the Reserve Bank extends to Australia's big banks in order to ensure complete market and public confidence in them. It's also worth noting that although the central bank is technically independent, it cannot act as a lender of last resort unless the market has total faith in the government that underwrites it.
Banks in general also cannot attract funding from private (wholesale) markets if those markets have no faith in the amount of capital the banks keep in reserve to wear future losses on bad loans.
In effect then ever since the GFC Australia's banks have been able to borrow at better rates thanks to the government's liquidity backstop, while also lending out more than $1 trillion at super profitable returns with bad debts at record lows.
I explain more about the principles behind the tax in this article and how the concept of "emergency money" exists when there is a sudden spike in demand for liquidity.
Westpac and its big 4 banking peers like Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd (ASX: NAB) then have little choice other than to cut dividends or attempt to pass the cost onto consumers primarily via higher home loan lending rates. I suspect they will try a mix of both and bank investors should brace for the prospect of dividend cuts thanks to the government's levy.
Still, with US 10-year treasuries sitting at just 2.25% arguably now is a good time to buy banks for investors taking a 3 to 5-year view. This is because benchmark lending rates look set to rise globally and the banks should have the opportunity to grow their net interest margins as their key measure of profitability.
