One of the first fallouts from Donald Trump’s surprise victory has been a surge in bond yields. This has pushed bank share prices higher, particularly in the USA, as they are expected to increase their net interest margin as interest rates rise.
In Australia, Westpac reported full-year results last Monday and CBA provided a quarterly trading update. This completed the round of profit results from the four major banks.
So, in an environment which may prove to be more conducive to banks, let’s pose the question – which bank?
Macro themes
Operationally, the major banks are now progressing very similar strategies. Following ANZ’s wind back of its Asian adventure, the exit by NAB from all offshore businesses, and changes to the wealth management businesses of ANZ, NAB and Westpac, the four major banks are now largely Australasian retail and commercial banks. Home loans, credit cards, personal loans, deposits, business loans, trade finance and payment services in Australia and New Zealand.
Westpac, ANZ and CBA are still pursuing institutional customers, while both Westpac and CBA run reasonably large wealth management businesses. That’s not to say that the other majors don’t play in these spaces – but rather, these activities are becoming less material to the major banks. Because the major banks have had to increase their capital by a combination of dilutive capital raisings and selling assets, their business focus is now squarely directed at the segments providing the highest and least volatile returns – personal and business customers in Australia.
Not surprisingly, pricing multiples have narrowed materially as the major banks compete for the same customers and business.
Financial Results
Looking at the bank results, they showed:
- Cash earnings up marginally, but the second half flat when compared with the first half;
- Risk weighted asset growth is very low, for some banks less than 2%;
- Bad debts weren’t as bad as some had thought. Although they are higher on a year-on-year basis, credit indicators remain quite strong;
- Return on equity has dropped – the new norm seems to fit in the 13% to 15% range;
- All Banks have capital ratios in excess of their (current) target range; and
- Banks were able to maintain their dividends (ANZ had previously announced a cut), but with Westpac and NAB adopting payout ratios of 80%, there is still risk of dividend cuts in FY17 or FY18.
Looking at the individual results:
- ANZ’s adjusted pro-forma cash profit of $6.97bn was down 2.5% on FY15, with the second half marginally weaker than the first half. The result was described by some analysts as “messy”, and included several one-off items. Highlights included organic capital generation with a CET 1 (common equity tier 1) ratio of 9.6% at 30 September, market share gains in home loans and progress in reducing costs;
- Commonwealth Bank provided a first-quarter trading update, with cash profit of $2.4bn flat with the corresponding quarter of 15/16. The Bank said that it maintained “positive jaws” (income growing faster than operating expenses), although the rate of income growth was below the rate achieved in FY16 of 5%. Higher insurance claims and a higher loan impairment expense impacted the overall outcome. The Bank’s CET 1 ratio was 9.4%, with the timing of the bank’s dividend payment impacting the 30 September outcome;
- NAB’s cash earnings for the year of $6.48bn were up 4.2% on FY15. Cash earnings in the second half of $3.26bn were flat on the first half. This reflected a fall in operating expenses, offset by a higher charge for bad and doubtful debts. Financial highlights included very marginally positive jaws (income grew at 2.5%, a higher rate than expenses growth of 2.2%), the banking cost-to-income ratio declining from 41.6% in the first half to 41.2% in the second half, and a steady ROE across both halves of 14.3%. NAB’s CET 1 ratio stood at 9.77%. It maintained its second-half dividend of 99c per share, with the full year of $1.98 representing a payout ratio of 80.8%; and
- Westpac’s cash earnings of $7.82bn were flat on FY15, and the second half flat on the first half. Core earnings, which excludes bad debts, was up by 3%. A strong performance by the consumer and business banks was offset by tougher conditions in the wealth and institutional divisions, with cash earnings in the latter falling by $240m compared to FY15. ROE dropped to 14%, with the Bank suggesting that it will be seeking to achieve a ROE in the range of 13% to 14% in the medium term. The Bank’s CET 1 ratio was 9.5%.
The Brokers’ views
The table below shows each major broker’s recommendation and target price for the four major banks (source: FNArena). The bank(s) with their highest recommendation is highlighted in yellow. For example, Citi has a buy on ANZ, but is neutral on CBA, NAB and Westpac.
Following the strong rally last week, most are now trading at, or very close to, the consensus target price. For example, the consensus target price for Commonwealth Bank is $76.01, which was just 0.3% higher than its closing price on Friday of $75.78. Westpac is flat, while the target price is 0.1% higher for ANZ and 3.2% higher for NAB.
Broker Recommendations and Target Prices
From this table, it is clear that the major brokers see little difference in value or price potential for the major banks. There is no standout.
The table below shows the broker consensus FY17 and FY18 forecast earnings multiples and forecast dividend yields. It also shows earnings-per-share growth between FY18 and FY17. On pricing multiples, the gaps are narrow. CBA is the most expensive, trading at 13.8 times FY17 earnings, while NAB is the cheapest at 11.7 times.
Forecast Earnings Multiples and Dividend Yields
Two other points to note. Earnings-per-share growth is very low, with ANZ the highest at 4.8% between FY18 and FY17, while virtually no growth is forecast for the NAB. Also, the brokers expect dividends to remain under pressure, with small dividend cuts forecast for NAB and Westpac, and CBA into FY18.
My view
I agree with the brokers in that the differences between the major banks are small. Historically, CBA has traded at a material premium to the other banks, however the gap from it to the cheapest bank, the NAB, is now just 17%. Against the ANZ it is into 11%.
With the bank with the highest ROE, leading market shares, and best technology, I expect CBA to retain a premium. I think that if NAB can execute on its Australasian retail and business strategy, and cut costs, then it can close the pricing gap.
In a very tight race, my order is:
- Commonwealth Bank
- National Australia Bank
- Westpac
- ANZ
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.