Some European banks have been great dividend payers in a zero interest rate world. At current market prices, Spanish banks such as Banco Santander, S.A. (ADR) (NYSE:SAN) and Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA), mostly known as BBVA, offer 8.5% and 4.6% cash dividend yields, respectively. But are those dividends sustainable? Let’s analyze each case separately and offer a viable solution.
Banco Santander, S.A. (ADR) (NYSE:SAN)’s Chairman, Emilio Botin, has maintained a high dividend throughout the financial crisis, even when profits were falling fast. Last year, the bank kept up its tradition of paying its huge dividend, even though earnings per share plummeted due to high impairments related to Spain’s sluggish economy. The bank’s 2012 payout ratio was just above 235%. This year, if the dividend is kept, the payout ratio should fall to 142% as EPS grows by more than 89% year-over-year as Credit Suisse’s analysts expect. Nevertheless, I wouldn’t expect a payout ratio below 100% until 2016.
The market believes Banco Santander, S.A. (ADR) (NYSE:SAN) will cut its high dividend. According to analysts at Citigroup and Barclays, the Spanish bank should cut its dividend soon. A report from Barclays reads as follows: “We see significant risk to the Banco Santander, S.A. (ADR) (NYSE:SAN) dividend.” That said, Santander has repeatedly insisted that it would not change its long standing policy of maintaining its existing dividend.
Since Banco Santander, S.A. (ADR) (NYSE:SAN) pays the bulk of its dividends distributing new equity to shareholders, I think the dividend is sustainable unless earnings do not recover as expected. The main short-term risk to the bank’s dividend is to be found in regulation. The European Central Bank or the Bank of Spain might regulate dividend payments, making a dividend cut impossible to avoid.
A much more sustainable proposition
Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA) offers a high, although sustainable, cash dividend yield. As a matter of fact, and despite some analysts expectations, I am confident of the sustainability of BBVA’s cash dividend if the bank would chose to keep such policy. The reason? Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA)’s 2012 payout ratio was just above 139%, and if earnings come up as expected (Credit Suisse’s analysts expect EPS to go up by 78% year-over-year), the ratio could fall down to 77.5% as soon as this year without touching the current cash disbursement.
Even when the expected payout ratio of Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA) is much lower than Banco Santander, S.A. (ADR) (NYSE:SAN)’s, the management at the former bank is not as committed as Botin to its cash dividend policy. Besides, Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA) is slightly more concentrated in Spain than Santander (Santander generates over 50% of attributable profits in Latin America and over 13% in the UK). As I explained in Santander’s case, the most relevant threat to Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA)’s current dividend can be found in regulation.
A proposed alternative
I have been looking at a viable alternative to Spanish high dividend payers. I found it in HSBC Holdings plc (ADR) (NYSE:HBC). The bank trades at a similar price to tangible book value multiple to Santander (which trades at 2013 134% price to tangible book value) and has a growing cash dividend. HSBC Holdings plc (ADR) (NYSE:HBC), with a payout ratio expected at 62%, currently pays a 4% cash dividend yield and is selling non-core assets and cutting costs in order to achieve the targeted 10.5% Basel 3 core capital ratio. After reaching its targeted capital ratio, the bank will return more cash to its shareholders.
The good news is that the bank is close to achieving its capital target. HSBC Holdings plc (ADR) (NYSE:HBC) has a Basel 3 core capital ratio of 10.1%. Hence, higher capital distributions are not as far away as the market seems to be expecting. I think HSBC Holdings plc (ADR) (NYSE:HBC) is a great option for those scared of the consequences of a potential dividend cut at Spain’s biggest bank.
I do not think that a dividend cut from Santander or BBVA is around the corner. That said, the Bank of Spain might want to limit cash dividends in the near future. Actually, a recent IMF report suggested that given current risks, cash dividends should be constrained. With this risk in mind, it’s good to start thinking of alternatives. I think HSBC Holdings plc (ADR) (NYSE:HBC) is a superb option with a great and growing dividend yield.
The article You Should Beware These High-Dividend Payers originally appeared on Fool.com and is written by Federico Zaldua.
Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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