Australian Banks Revisited

This story features WESTPAC BANKING CORPORATION, and other companies. For more info SHARE ANALYSIS: WBC

By Greg Peel

FNArena last reviewed the current consensus standings for the Big Four Aussie banks in early May in the wake of the first half result season for Westpac ((WBC)), ANZ ((ANZ)) and National ((NAB)). At the time the ASX 200 had already fallen by just under half of what this latest Greek-inspired correction has ultimately wrought, being a total of 9% from the April peak of 4971 to yesterday's close of 4529. Pedants might suggest a market has to fall 10% before being “officially” called a correction, but FNArena considers such trivia to be a load of rubbish.

Of course the “Sell in May” correction has not only been a result of Groundhog Day Greece but also of weak US economic data and the pending end of QE2, the immediate impact of the Japanese earthquake, Chinese tightening to fight inflation, and, peculiar to Australia, the ongoing currency impact and the negative March quarter GDP. So if we assume the Greek story will once again fade for now, we're not necessarily out of the woods just yet.

There is nevertheless a popular view that the second half of 2011 will be more positive for the global economy, with Greece resolution one matter but expectations of easing Chinese inflation growth, a swift Japanese rebound, and solid US corporate earnings forecasts for the June quarter being catalysts. Then there's always history – the “Sell in May” impact usually loses momentum around July-August.

In Australia the RBA remains hawkish with investment in the resources sector outweighing a weak economy elsewhere, such that a rate rise is expected by economists in August. The June quarter GDP will show a bounce out of the disaster-ridden March quarter mire but may yet show another negative result, in which case the same people who wait for a 10% pullback to declare “correction” will be quick to declare “recession”. Oh God, I can just hear Joe Hockey now. But this label, too, is a load of rubbish. Australia is already in as good as a recession everywhere expect for the resources sector, and we may yet see a positive GDP result for June anyway.

The problem for banks, however, is that mortgage demand is not being driven by miners who are either living in demountables or buying property for cash. On the home loan front, Citi best summed it up in a report last week by suggesting, “Volume growth is expected to be lower because of the rising interest rate burden for rate sensitive customers, a general consumer interest in deleveraging, falling real estate volumes, and widespread softening in real estate prices”. A Macquarie report this week adds, “Similarly business investment intentions outside the mining sector remain extremely weak meaning business lending is likely to remain weak for the foreseeable future as well”.

And that is the situation Australia's banks find themselves in as we wrap up what is for most FY11, albeit only CBA accounts on a June basis while the other three have a September year-end.

In the May Australian Bank Earnings Review, ANZ lost its position as the number one preference by broker consensus as the bank's margin premium due to Asian deposits began to narrow. NAB took ANZ's place after a strong mortgage performance fuelled by its nauseating ad campaign, and signs of stability in its UK and toxic asset positions. CBA and Westpac are already loaded with mortgages so weak business lending kept brokers subdued. CBA was seen to be close to fair value based on its perennial “big bank” premium while Westpac (which is actually “bigger” but coping with a risky St George franchise) was seen to offer the least value after a decent relative share price run, and as such scored no Buy ratings

Bear in mind that when global credit fears re-emerge it's always the smaller ANZ and NAB which cop the biggest hiding from nervous investors.

This was the state of play in May:

Moving on to our end-June summation, Macquarie notes FY11 sector growth will come in around 5% but the analysts suggest this looks like a cyclical low. Citi analysts have nevertheless cut their system loan growth assumption for FY12 to 4% from 6%, noting that Australian “interest in purchasing real estate and shares” (which is probably sourced from Westpac's regular consumer confidence surveys) has fallen to a 15-year low.

All sound pretty dour really, if you're an Australian bank investor.

But actually, it's not. For one thing, consumer frugality has meant ongoing strong deposit growth which takes the pressure off expensive offshore funding and hence alleviates the margin squeeze analysts would otherwise have expected. Banks would still rather write more business, but higher deposit levels are a concession in the meantime and help satisfy capital requirements under the new Basel III rules.

What this means is that Citi, having dropped its FY12 loan growth forecast to 4% from 6%, has only reduced its sector earnings forecast by 1% on the deposit-side balance. Citi is not alone, for despite ratings changes amongst the FNArena database brokers, consensus price targets have barely changed from May to now:

The most notable change here is that Westpac has scored two upgrades to Buy from Hold in the interim, moving it into equal third position with CBA. Clearly Westpac shares have suffered a pullback over the past six weeks but what is noticeable is its forecast yield numbers. At this level, broker consensus has Westpac yielding 7.0% in FY11, fully franked, and 7.4% in FY12. By contrast, ANZ is offering 6.5% and 7.0% and NAB 6.8% and 7.4%, while CBA is offering 6.7% for FY12 (with FY11 ending today).

BA-Merrill Lynch also notes Westpac was, again, the only major to record positive net retail fund flows in the March quarter.

After tax yields of around 7% for the safest banks in the world (in many an opinion) are not to be sniffed at, particularly given the banks will be at the forefront of any second half stock market rally, were that to occur. Macquarie thinks it will.

Macquarie notes that the RBA's hawkish stance – that which is keeping potential borrowers on the sidelines and driving others to pay down debt – is a reflection of cost-push inflation caused by “supernormal strength” in the Chinese economy. Economists are expecting China's inflation growth problem to ease in the second half, and Premier Wen concurs, and as such result in a more stable outlook for RBA rates. This would have positive implications for domestic asset growth, Macquarie suggests, as would the resolution of other global uncertainties such as European debt and slowing US growth.

The second half should also see another little boost in the form of our friends across the ditch.

While the connection to New Zealand is somewhat obvious for ANZ, RBS analysts remind us that Big Four earnings in the first half saw contributions from New Zealand of between 6% and 16%. With post-quake rebuilding efforts now underway, and both fiscal and monetary stimulus being provided by the NZ government and RBNZ respectively, RBS suggests the recovery in NZ loan growth should begin to gain traction in the second half. At the same time, direct quake-related losses for the Big Four should be minimal, just as they were unsubstantial in the wake of the Queensland floods.

So while the Big Four were looking unexciting as investments back at the April highs, at which time most analysts were declaring “fair value”, today the story is somewhat different following the correction. One need only look at consensus price targets from May to now in the tables above – they've barely moved as noted. What have moved, however, are the upside to target measures, which are now quite substantial. In other words, analysts don't see any impact of note to the Big Four from those global factors behind the correction.

Unfortunately the same can't be said for Australia's poor old investment bank, which was once the envy of the world. With the GFC bringing Macquarie Group's ((MQG)) fund model to an end, the bank must now rely on fees and profits from financial market trading and M&A activity, and yet another global market scare has meant those numbers are still nowhere near to returning to “normal”.

Deutsche Bank believes Macquarie is now looking cheap from a fundamental point of view given the analysts' expectation the group can again boast return on equity levels of 15-20% some time in the future, but right at the moment it seems a fairly distant dream. With talented staff finding better offers elsewhere the once superior Macquarie franchise has become tainted, and the credit ratings agencies are circling on a sniff of blood.

Deutsche this morning slashed its 12-month price target for MQG to $33 from $44 and downgraded to Hold. The thousandaires factory now has a Buy/Hold/Sell ratio of 2/4/1.
 

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