Banks or BHP?

Banks or BHP?

Are Australian banks going to be able to sustain their dividends? Over the last ten years, bank fee income has become a big driver of bank profitability (and the source of the dividends paid by banks). The credit crunch has crunched the amount of money banks make lending money. The net interest margin – the difference between what Aussie banks pay to borrow from overseas and what they make lending domestically – has been shrinking.

Here’s a question then…if the bank’s cut their fees, are they cutting off their own heads? For example, NAB is axing its penalty fees for overdrawn accounts. A Reserve Bank study published in May showed that so-called “exception fees” resulted in $1.2 billion in fee charges to Aussie households – or 10.34% of total bank fee income for the year.

Total domestic bank fee income for Aussie banks was up 8% last year to $11.6 billion. You can see from the chart below that fee income has been growing by about 11% the last few years. But keep in mind that aggregate profits of the Big Four banks last year were $15.9 billion. That means fees accounted for nearly 73% of total bank profits, according to our back-of-the-envelope math.

Source: Reserve Bank of Australia, Banking Fees in Australia in 2009

This actually shows you how bad a business banking typically should be. You can only make money lending money by taking more risk (both as a borrower on international capital markets and a lender on the domestic residential real estate market). If you take less risk, you have to make up for the fall in income by raising fees, which infuriates customers and law makers. Banking isn’t a low margin business. But maybe it’s headed that way.

Speaking of cash, should BHP sending more cash to share holders? That’s the question some investors are beginning to ask, according to Bloomberg. Our co-Melbourne based commodity giant told investors that its record of seven consecutive profit results has ended. Underlying full-year profit for 2009 was down 30% to $12.8 billion on the back of lower commodity prices and demand in the fiscal year.

But the company left its dividend in line with the second half of last year at US 41 cents per share. It did not increase the dividend. However that dividend is 17.1% larger than the year before. So why not give back more cash to investors?

Mining is a capital-intensive business. BHP has been around the commodity block a few times. It knows that to expand production when commodity demand picks up requires cash. You have to keep that cash around for a rainy day for when the cycle turns.

Or, conversely, if the cycle turns down again – as it might if the global recession takes a second, depressionary dip – the cash is a bulwark against weak demand. It’s also nice to have a war-chest to buy out asset-rich, cash-poor firms that cannot ride out a sustained drought in earnings when production is shuttered. BHP remains in a better capital position than nearly all its global rivals.

But if you don’t want to put your capital risk in common stock, why not have a look at the new inflation-indexed bonds being issued by the Federal government for the first time in six years? Yesterday’s Age reports that the Australian Office of Financial Management plans to introduce the bonds back to the market in September or October of next year.

Finding assets that deliver a return greater than the rate of inflation is going to be the big challenge in the years ahead. Inflation-indexed bonds are one strategy. Small cap growth stocks are another (especially precious metals and energy stocks leveraged to higher gold and oil prices). Emerging markets are a third. We’ll ask the Australian Wealth Gameplan editor what he thinks of these bonds and get back to you tomorrow.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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3 Comments on "Banks or BHP?"

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I think the growth for the banks is going to come from the fact they basically ‘own’ the superannuation industry, lush fees and charges to clip for years to come, compounding away, with fresh money coming in, guaranteed. If they lose capital on the super side of the business, who cares…it’s not the banks money. Also let’s not forget that the slaves/taxpayers guarantee to bail them out when they make a whoopsie on the banking side of the biz. All this action and it’s perfectly legal. On the other hand, bhp has to actually do something for their money by… Read more »

Less dividend ratio is okay…if it is expected to pick up at a later date, or if the money is being used to make the company grow (and hence share price appreciation).

But companies that are not expected to grow and who release little in the way of dividends can expect their share price to reflect the low dividend ratio.

It is something to consider if you are thinking of buying some shares and think they might be overpriced. When economies go pear-shaped, a lot of things start to look overpriced. However the rebounding growth potential can be tempting.

Perhaps when comparing banks, the concept of power is relevant. For example, a bank which finances things which are usually the role of government (essential services and infrastructure) is in a unique position because it can exert leverage on government to tailor policy to the bank’s advantage. A bank which has this kind of control is more likely to create profitable markets for itself whilst undercutting the competition by reducing its various fees. The FHBG is an example of how this has worked in the past (for banks in general), but the next economic cycle (whatever the hell that means)… Read more »
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