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Why it’s a good thing that banks are cutting dividends

Tristan Harrison
Price cut

I believe it’s a good thing that banks like National Australia Bank (ASX: NAB) and Westpac Banking Corp (ASX: WBC) are cutting their dividends.

Obviously, it’s not helpful for retirees who rely on the dividend income paid every six months. I have been warning for some time that the big banks may have to cut their dividends.

This morning we saw a dividend cut of 16% from NAB. It certainly wasn’t a surprise because the half-year dividend was also cut by that amount.

One of the main reasons that NAB and Westpac cut dividends is because they have to meet the ‘unquestionably strong’ capital ratio set by APRA. The deadline for this is just around the corner and the banks are simultaneously paying large amounts of customer remediation.

But there’s also the argument that banks need to retain more of their profits so that they can re-invest for growth.

Banks earn most of their profit from the net interest margin generated. But the net interest margin (NIM) is declining with these record low interest rates. The other sources of bank earnings are coming under pressure from a variety of places including technology companies.

If banks like NAB and Westpac are going to have a chance of growing profit they need to put money into new growth areas.

Lending for mortgages is becoming more like a commodity product, which is partly when bank NIMs have been slowly falling over the long-term from more competition. I think they need earnings diversification.

Whilst Telstra Corporation Ltd’s (ASX: TLS) dividend cut was also painful, it was necessary for the telco to invest more for growth rather than pay out all of its earnings every year.

Australia and New Zealand Banking Group (ASX: ANZ) didn’t give shareholders a dividend cut, they just saw a franking credit reduction. But that shouldn’t be surprising considering more of its profit is being generated overseas which doesn’t create franking credits.

Foolish takeaway

Keeping some profit is necessary to grow future profits. It’s not as though the banks don’t have high yields any more. Based on the new dividends, NAB has a grossed-up dividend yield of 8.3% and Westpac has a grossed-up dividend yield of 8.3% as well.

The post Why it’s a good thing that banks are cutting dividends appeared first on Motley Fool Australia.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019