A prominent portfolio manager has predicted that findings from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry will spark increased competition and lower dividends within institutional banking.
SG Hiscock and Company’s Hamish Tadgell, speaking at a media lunch this week in Sydney, said the firm was “very underweight” the big four banks, which would be forced to cut dividends by up to 50 per cent if they continued to delay making a change.
“When boards of directors sit down and decide how they’re going to pay their dividend and policy, and whether they’ll pay a big fully franked dividend to a big retail base, they don’t talk about whether it’s shifting a cent or half a cent,” Tadgell said. “They hold onto that as long as they can until this capitulation point where they can’t – and it halves.”
Tadgell said increased competition would be the natural consequence of the commission’s recommendations – much like after the UK financial services commission in 2012 – and could result in a new generation of players joining the likes of ME Bank in trying to usurp the big four.
“The royal commission doesn’t actually have a mandate to introduce more competition, but my view is that it will be a consequence of the recommendations,” he explained. “How did that competition manifest itself in the UK? They made it easier for banks to get licences. There were 14 new challenger bank licences issued in the UK after that inquiry, so it’s going to be interesting to see if the government [in Australia] is going to make it easier for other banking licences to come in.”
Tadgell also identified several other risks to banking profitability – Labor’s proposed cuts to franking credits and increased competition in wealth platforms among them – as reasons the banks could end up slashing dividends by half.
“It’s not sustainable,” he said. “This, for my view, is the big risk with the bank – the dividends at some point become unsustainable.”
Tight squeeze
Commissioner Kenneth Hayne’s recommendations could do more to the banks than facilitate increased competition. Despite starting to retreat from the wealth space, they are all still largely involved; changes to fee structures, grandfathered commissions and vertical integration would cause further damage to brand and bottom line.
Hayne’s recommendations will also probably target lending practices, which could further constrict mortgage books already pared back after 18 months of tightening.
Tadgell expected dividends to take a back seat once the banks started to reshape in this new environment, as funds would be diverted to consolidation efforts.
“The question long term is – what will the banks look like [in a] steady state? They’ll shrink back to their core…mortgage books, probably some SMEs, some business lending,” he argued. “It’s probably a lower growth state than what they’ve probably been. The risk then is that they need to reinvest back in the businesses to maintain that growth in a more competitive environment.”
‘A-ha moment’
Tadgell said the banks could look like Telstra – whose share price has more than halved since 2015 amidst fierce competition from newer market players – in “five to seven years”.
“Think about Telstra – a monopoly, oligopoly-type asset,” he said. “With more and more competition coming, the core of their business has come under a lot of pressure. The copper is shrinking dramatically, mobile’s shrinking dramatically.”
Tadgell compared the pressure on Telstra’s core assets to the pressure on mortgage books for the banks, and said the strain on similar assets would lead to an “a-ha moment”, at which dividend cuts would become the only option.
While the timing of this would be “hard to predict”, due in part to the probability of regulatory change, the effect on share prices could be painfully similar to Telstra’s fate.
“We see some pretty big secular and structural issues that are going to continue to play out,” he said.
