Franking Credit Reductions

In late 2019, both ANZ and Macquarie Group (MQG) lowered the franking credits attached to their ordinary dividends and Additional Tier 1 (AT1) instrument distributions.

ANZ lowered this to 70% from 100% whilst MQG lowered it to 40% from 45%. This franking rate will also be attached to distributions on Macquarie Bank's (MBL's) relevant instruments.

In our view, these actions have been a long-time coming with structural shifts in both entities operating models leading to a higher proportion of offshore income and underperforming Australian units.

In theory, a company with 100% profitable earnings generated and taxed within Australia should be able to pay dividends (or distributions) which are always franked to 100%. In ANZ's case, it has sold Australian businesses and those that remain are not as profitable - crimping the Group's franking credit generation once these profits are taxed.

Of the four major banks, ANZ was always the one at most risk of this action and markets should have first been concerned back in 2015 with the Group's franking account balance available for future distribution almost halving to $593m. This stood at just $97 million at the end of FY18.

We believe the likelihood of peer major banks following this action as unlikely with these entities operating a larger proportion of their businesses profitably within Australia and they also hold much larger franking credit balances (we note this may change adversely in the future).

For AT1 or hybrid investors, the total gross distribution is unchanged from the above actions but as the franked component decreases, the absolute cash component increases to compensate. We have updated all of the relevant instruments in our coverage in-line with new ASX announcements. Tier 2 (non-discretionary subordinated debt) instruments are stucturally unaffected by this franking credit change.

We do expect some minor adjustments to trading margins for these two entities and it will be particularly interesting if a material difference emerges between ANZ's AT1 instruments and peer banks'.