The bank reporting season, which delivered annual results for three major banks and a brief quarterly update from the CBA, can only be described as underwhelming. For ANZ, NAB and Westpac, the market took an immediate dislike to their full year results and shaved off around 2% from the share price on the day of release. Since the season kicked off on 25 October, the major banks have underperformed in the market by around 3%.
Why the disappointment?
Well, it is not a function of missing the headline profit number, because they largely met analysts’ forecasts. ANZ with a cash profit of $6.94bn, NAB with $6.64bn and Westpac with $8.06bn. CBA’s quarterly result of $2.65bn did better, largely on the back of a huge fall in loan impairment expenses. No beats, but not misses either.
The problem is that in each case they are largely growthless. Lending volumes are flat, and while margins have improved, ongoing switching from interest only home loans to principal and interest will act as a headwind, while the full year impact of the bank levy will also take a toll. Non-interest income is under pressure as they respond to consumer disquiet and initiate actions such as cutting ATM fees. Aspirations to expand into Asia have been abandoned, and the majors are divesting of core parts of their wealth management businesses. There are opportunities in the institutional business, but this is frowned on by the investment community due to the volatility of earnings and (often) lower ROEs. So, the problem is – how do they grow revenue?
Meanwhile, each of the majors is “talking” about cutting costs, but the progress is slow. ANZ was the only bank to reduce costs in absolute terms, albeit by just 1.5% on an underlying basis for the full year and 0.3% in the second half. The market expected more progress (rather than talk) on cutting costs – this is what disappointed the market.
* CBA’s 1st quarter was up 4% on their second half quarterly average
There are positives
One of the main positives for the Banks is that the capital challenge is largely over. While the regulator APRA might yet make some further refinements to mortgage risk weights, particularly for higher risk loans, three of the four major banks have complied (or will comply) with APRA’s “unquestionably strong” benchmark of a Common Equity Tier 1 (CET 1) ratio of 10.5% more than 2 years before the deadline of 1 January, 2020. Westpac and ANZ at 10.6% are already there, with ANZ’s ratio set to rise by another 80bp when the divestment of its wealth and Asian retail banking is completed. CBA reported a ratio of 10.1%, but said that on a proforma basis, this will rise to 10.8% when the sale of its life insurance operations completes in 2018.
Bank Capital Ratios as at 30 September 2017
National Australia Bank has a little more to do, but is confident that it will meet the target in an orderly manner. This takes off the table for good the potential for capital raisings such as a rights issue (unless one of the major’s goes on an acquisition spree).
It also raises the prospect of capital returns in the medium term. ANZ has said that it will undertake a capital return of around $3bn to $5bn in FY18 and FY19, most likely via on-market buybacks (it doesn’t have a surplus of franking credits).
Moreover, dividends look reasonably secure. While dividends ultimately depend on earnings, and increasing dividends depends on increasing earnings, Commonwealth Bank and ANZ dividends aren’t in any doubt. Westpac, which had a payout ratio 78.4% in FY17, is probably ok. National Australia Bank is most at risk with a payout ratio of 82.6% in FY17, but you would expect that the Board and Management will work very hard not to cut the dividend.
Another positive is that there are no signs of any deterioration in loan impairment (bad debt) expenses or the quality of the asset book, outside a rise in WA home loan delinquencies. In the September quarter, CBA recorded record low impairments at just 11bp or 0.11% of their gross loan books, while Westpac’s loss for the full year was 13bp.
What do the brokers say
The major brokers are largely neutral on the banking sector, and neutral on the individual banks. The following table shows the recommendations of the eight major brokers (source: FN arena), together with each broker’s target price.
Broker Forecasts
In summary, each bank is seen as being priced close to the target valuation. National Australia Bank is the furthest away from its target price at a 5.1% discount, while Commonwealth Bank is currently trading 2.9% above the target price. However, these differences are relatively small and each bank is seen as being close to full valuation.
NAB is Credit Suisse’s preferred bank, but the least preferred for UBS. Morgan Stanley on the other hand likes Westpac, while Macquarie opts for ANZ and NAB.
While these are preferences, it is also fair to say that there are no standouts. This is rational given that the differences now between the banks in strategies, customer service, management bench strength and even technology are relatively minor.
On a multiple of earnings, CBA and Westpac still trade at a small premium to the other banks. As the following table shows, CBA is currently priced on a multiple of 13.9 times FY18 earnings. ANZ is the cheapest on a multiple of 13.0 times forecast FY18 earnings and 12.6 times FY19 earnings.
My view
The differences are very small. CBA has the best franchise, technology and return on equity, and its premium to the other banks has narrowed considerably. However, until such time as the AUSTRAC court proceedings, APRA’s independent prudential inquiry into governance, culture and accountability at the CBA, and shareholder class actions are out of the way, it is hard to recommend it because the risk is that these go on for an extended period of time.
ANZ looks the most serious about cutting costs and is further down the path than the other majors. NAB has announced that 6,000 jobs will go over the next 3 years, but is also warning that costs will rise next year by 5% to 8% due to higher investment spend, before flat lining to FY20. Westpac is targeting a cost to income ratio under 40%, but is investing and seems comfortable with cost growth of 2% to 3% pa.
ANZ by a nose. Neutral on the sector.
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