Why your dividends from the big four banks are under threat

The big four banks are on the back foot following an order from the Australian Prudential Regulation Authority (APRA) for dividend reductions, while global credit ratings Fitch downgraded their long-term issuer default rating from AA+ to A-.

APRA says it expects "prudent reductions in dividends", but stopped short of scrapping dividends altogether. Upcoming dividends should instead be issued at a "materially reduced level".

This will be a hit for SMSF trustees, super funds, and other income investors who rely on dividends as a major source of income.

How big a hit, exactly, is an open question.

Some experts believe banks will cut, but not eliminate, their dividends.

"Boards are unlikely to get rid of dividends entirely," says Scott Kelly from DNR Capital.

"One, there are a lot of investors who rely on dividends for income, so cutting it out altogether would have an escalating impact on the economy, and two, bank shareholders are mostly retail investors so cutting dividends to zero would significantly decrease the share price."

Kelly notes that the APRA announcement isn't a direction to suspend, but rather a set of guidelines for boards to follow, which allows them to make decisions that will lead to some kind of dividend being paid in the short term.

Drew Meredith from Wattle Partners believes the APRA announcement is symptomatic of a trend already in motion.

"Banks are among the most well-capitalised in the world. Payout ratios were 95% in some cases, so dividends were bound to come down."

The downgrade from Fitch is also likely to have less impact than investors may think.

"Longer term might increase cost for banks to source funding, but in short term Reserve Bank of Australia is ensuring cost of funding stays low.

"We're still talking about investment grade, so it won't move the needle too much."

Still, there are other places income investors can look to get their dividends.

"There are better dividend plays on offer at the moment," says Kelly.

Both Kelly and Meredith like Amcor (AMC) and Aurora Labs (A3D).

Kanish Chugh from ETF Securities adds that the current environment may be reason for investors to look overseas.

"There is a need to consider diversification, not just across markets."

"If you're invested in an income ETF, be aware of when those indexes rebalance, and what the benchmark provider is doing to accommodate for this changing world."

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