Looking For An Above Average Yield? Australia’s Westpac Banking Looks Very Attractive After Today’s Financial Sector Selling But I’d Wait On A Likely Dividend Cut This Fall

Today’s weakness in the financial sector on the news that online brokerage Charles Schwab (SCHW) will be cutting commissions on equity and ETF trades to 0% sent the financial sector down to a loss of 2.07% on the Financial Select Sector SPDR ETF (XLF).

That drop–plus good news from Australia’s housing market–would seem to open up a window for any income investor looking for an above average yield from shares of Westpac Banking (WBK) without adding big risk to a portfolio. But the opening is deceptive and I’d wait a bit until after the likely announcement of a modest dividend cut sometime this fall.

Westpac Banking (WBK), Australia’s second largest bank, fell 1.43%, today October 1, with the rest of the financial sector. The stock, a member of my Dividend Portfolio, now pays a trailing 12-month dividend of 6.52%. The shares have gained 22.96% in price since I added them to the Dividend Portfolio on February 3, 2012.

The news reported yesterday about the Australian housing market–which from a bank’s perspective means the mortgage lending market–suggests that the price on this stock is safe at these levels.

Or it will be after the bank announces this fall that it will cut its dividend for 2020.

The problem isn’t with Westpac’s market or the important Australian mortgage market. Australian housing prices rose in September as the rebound in the country’s housing market continues to build momentum. Housing prices in Sydney and Melbourne rose by 1.7% in each city last month. The news isn’t nearly as good in smaller towns such as Hobart and Darwin where prices continue to decline. But on average the national trend is pointing upward.

So why is the company contemplating a dividend cut? The Australian Prudential Regulation Authority’s, has set a very high bar of 10.5% for the common equity Tier 1 ratio. According to Morningstar, Westpac Banking is likely to miss that target by the end of the year unless it cuts its target dividend payout ratio of 70% to 75%. (The actual payout ratio has climbed to 80% recently.) The necessary cut in dividend payout doesn’t have to be very large–Morningstar estimates about 12% to AUS$1.65 a share from AUU$1.88. That would bring the payout ratio down to 76%. And would still leave Westpac as a high yield star in a market without many of them.

I’d use any temporary drop in Westpac shares on the announcement of a dividend reduction to start or build on positions. I am not selling my position out of the Dividend Portfolio because I don’t expect any dip to be particularly deep or long-lasting. Morningstar’s one-year target price of Westpac is $22 a share. The stock closed at $19.70 on October 1.