Franking accounts overflowing

Large Australian companies, with the banks prominent among them, have accumulated massive franking account balances over the past couple of years and are facing pressure from investors to start paying higher dividends to get those credits off their balance sheets.

A note issued by RBS Equities yesterday puts the balance of franking credits held by the top 100 companies on the Australian Securities Exchange at $37 billion, with credits accumulating in franking accounts 33 per cent faster than they are being distributed.

According to RBS the biggest balances are held by the miners BHP Billiton and Rio Tinto, with Woodside close behind.

Westpac is fourth with a balance of $2.7 billion, up from $709 million in 2008. National Australia Bank has a $617 million franking account balance, Commonwealth Bank $758 million, Suncorp $631 million and ANZ $49 million.

Companies accumulate franking credits as they pay their tax. Those credits only have value in the hands of shareholders and can only be distributed when they are attached to dividends.

As companies have cut back their dividend payout ratios over the past couple of years to strengthen their balance sheets, the franking accounts balances have grown.

RBS expects that there will be pressure from shareholders during the upcoming profit reporting season for companies to lift their payout ratios and start clearing those franking accounts.

There will be added pressure on companies because they have greater flexibility in paying dividends as a result of an amendment to the Corporations Act.

Under the old rule dividends could only be paid out of the profits of the company.

The new test, in section 254T of the Act, says a company "may no longer pay dividends unless": the company's assets exceed liabilities and the excess is sufficient for the payment of the dividend; the payment of the dividend is fair and reasonable to the company's shareholders as a whole; and the payment of the dividend does not materially prejudice the company's ability to pay its creditors.

What this means is that directors are no longer restricted to paying dividends out of profit. Companies with earnings that have been affected by non-cash items will be able to pay dividends.

RBS anticipates a strong focus on "post-tax portfolio management" during the reporting season.