National Australia Bank Ltd (ASX: NAB) has become the first big bank to sacrifice its sacred dividend cow this morning by telling shareholders its interim dividend for the six-month period to March 31 2019 will fall by 16% to 83 cents per share.
It did not provide guidance for the likely amount of the final dividend in six months' time but it's a fair expectation it will be in line with today's payout.
The stock closed at $25.78 yesterday to mean it would offer a yield of 6.4% plus full franking credits on the basis that it pays out $1.66 per share in dividends over the next 12 months.
For the period cash earnings came in at $2,954 million after some heavy compensation and restructuring costs, which translated into $1.025 in cash earnings per share.
Paying a dividend of 83 cents on these earnings equals a reduced payout ratio around 83% (or 77% according to NAB's own presentation), compared to the prior 4 fiscal years where management chose to pay out nearly all cash earnings in dividends to appease investors and paint a strong (if slightly misleading) short-term picture of management's own performance.
Paying out too much of cash earnings in dividends is a mistake another blue-chip dividend share favourite in Telstra Corporation Ltd (ASX: TLS) made over the past few years, with disastrous consequences for its share price.
In fairness to NAB and its management team it has faced problems (arguably self inflicted) from the fallout from the Royal Commission, the headwind of falling house prices, rising overseas wholesale funding costs, and tighter prudential regulations crimping its lending growth.
On a basic level the more a bank can lend (on a risk-adjusted basis) the more profit it can make as banks profit by making more on what they lend than they pay on what they borrow. The difference being the two rates being the net interest margin as a key measure of banking profitability.
NAB's group net interest margin came in 8 basis points lower than the prior corresponding period at 1.79%, which is lower than its big 4 rivals such as Commonwealth Bank of Australia (ASX: CBA).
However, for riskier lending areas (where lending rates are higher as loans are less well secured) such as business lending the NIM came in at 2.94%.
In Australia though the juiciest profits for all the banks are still made in the home loan (mortgage) lending market as this is by far the largest and most well collateralised market as the loans are secured by equity in the physical property.
As such bad debts are low but net interest margins also low at 1.16% (for the half) due to the competitive nature of the market as the collateral makes this lending relatively low risk and very profitable.
The problem for all the banks though generally has been the regulators' demands that they treat customers more fairly and hold back more capital as a percentage of risk weighted assets (home / business loans on the balance sheet, etc) in order to make the banks "unquestionably strong" in the event of a liquidity crisis or major economic downturn.
The tighter requirements to hold more cash in reserve for a 'stormy day' is what hurts the banks' return on equity (ROE) as idle capital held in reserve cannot be lent out for profitable purposes. Return on equity is a key indicator of investment profitability for professional share market or even property investors, so a falling ROE is not good for a share price over the long term.
Outlook
I am not surprised the NAB has cut its dividend more than the market expected as I expect management wants to reset the business so it does not have to cut its dividend again in the next couple of years.
However, it would be a mistake to think more dividend cuts from NAB are unlikely due to the well known headwinds in the local economy and housing market that feed NAB's key profit streams.
Moreover, the recent expenses scandal at the NAB that has lead to two arrests, including of the former CEO's long-serving assistant, does not speak well of the corporate governance, culture and audit functions at the bank. While its senior management team's focus on shareholder returns also comes into question. No surprise NAB shares have long underperformed their big 4 rivals.
As such I'm not a buyer of NAB shares.