Are Oz Banks Overvalued?

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

-Banks positioned to extend more credit
-Margin story remains a concern for CIMB
-Are valuations stretched?
-Margin outlook is positive for JP Morgan
 

By Eva Brocklehurst

Brokers agree Australian banks are in a good position but the outlook diverges when it comes how fairly valued they are. For Macquarie, the banks have the latitude now to do more heavy lifting when it comes to extending credit to help businesses grow. CIMB finds the margin story still a concern and believes valuations are stretched, so has downgraded the sector. JP Morgan takes a close look at the secondary bond market and takes a longer view, upgrading bank earnings forecasts.

Macquarie, from the collaborative survey with East & Partners, finds the banks are well able to fund the next stage in economic growth by easing credit restrictions, as businesses are generally more relaxed about the future. Borrowing intentions are on the rise, although on a state basis the two-speed economy remains in place. Macquarie notes a difference in loan appetite between the resource states of Queensland and Western Australia and the rest. The commodity price volatility of 2012 appears to have had little impact on intentions to borrow. The industries within Queensland and WA that are likely to drive the growth in borrowings are those exposed to the mining and energy supply chain, including equipment finance. There is not much change in NSW and Victorian borrowing intentions and the other states are decreasing.

So, there is demand for loans, particularly from the institutional and corporate client base of banks, with small-medium enterprises remaining relatively flat. It suggests to Macquarie that, at the very least, larger businesses are gaining confidence in the economic outlook and are willing to take on more debt. Macquarie still accepts there is margin pressure for the banks and the competition for institutional lending remains high. When credit was tight the banks were driving growth through lending fees. Macquarie now expects fee penetration will flatten but, as loan volumes grow, there will be a tail wind for the banks in lending fees.

Macquarie did find a disparity between the stress levels expected by larger corporates and institutions and the micro and small business sector. In the latter segment, concerns about obtaining credit remain elevated. The conclusion that debt availability is a driver of stress is supported by the working capital and/or equity issues impacting on smaller business confidence. If these trends continue, Macquarie believes the economic rebound should most favour the banks with greater corporate business emphasis.

This spotlight falls on National Australia Bank ((NAB)) and ANZ Banking Group ((ANZ)). The broker decided to upgrade NAB to Buy, finding NAB has the highest adjustment to earnings forecasts. NAB is now top pick for Macquarie. ANZ is second, as the rebound in business banking asset growth and re-pricing is not considered enough to offset high funding costs and increased competition for institutional client. A Buy rating is retained. Improvements in credit growth for Commonwealth Bank ((CBA)) are seen balanced out by margin decline, hence a Hold rating. Westpac Banking Group's ((WBC)) business banking income is expected to rise with increased fee penetration. Westpac is expected to benefit relatively less from a surge in corporate and institutional loan growth and a Hold rating is also retained.

CIMB is negative about the staying power of margin pressure. This broker has revised NAB down to Hold from Buy, having reviewed lending and funding for the banking sector. CIMB has no Buy ratings on the majors and retains Hold ratings for WBC and ANZ. CIMB rates CBA as a Sell. The broker views risks are on the downside for interest margins, stemming from the institutional margins and a cash rate that could stay lower for longer.

CIMB expects more pressure to emerge in FY13 on spreads in term deposits and savings and transaction accounts. Underpinning the broker's viewpoint is the limited asset re-pricing opportunities. CIMB suspects the improvement in wholesale funding spreads and the impending federal election will put an end to further re-pricing. The broker also notes the pressure on margins is coming more substantially from the institutions. Deposit pressure is unlikely to unwind and the broker believes this will drag on margins.

Lower base rates are a medium-term risk in the broker's view. Taking three years to allow interest rate swaps to rest at a lower base means a 1% fall in interest rates against the FY12 average could result in a 9% hit to the sector's earnings. Furthermore, there is still some uncertainty on liquidity requirements. CIMB expects regulators won't allow banks to increase holdings of government securities and the margin headwinds associated with the build up in liquidity should ease. The broker admits wholesale funding improvement is a key source of upside risk, but accounts for half of the benefit of better spreads only if this funding staying at current levels until FY16. This would eventually boost bank margins by 10-12 basis points.

JP Morgan finds the glass half full. The broker expects improved wholesale funding costs should transmit to deposit spreads and has upgraded earnings forecasts for the banks for FY14 and FY15 on an improved margin outlook. It's just a matter of a bit more time in JP Morgan's scenario. The broker's major bank margin forecasts still envisage some FY13 headwinds, with easing term debt spreads providing a relatively stronger benefit in FY14. The broker cites minutes from the RBA's recent monetary policy meeting, which highlighted an expectation that declining term debt spreads would take some time to be reflected in average costs. To add JP Morgan's view on the major banks to the mix, there is a Buy recommendation for NAB. ANZ and CBA are rated Hold, Westpac is rated Sell.

On the FNArena database the major banks score very mixed ratings. For NAB there are three Buy, four Hold and one Sell. For ANZ there are five Buy, two Hold and one Sell. WBC has one Buy, six Hold and one Sell. CBA has one Buy, three Hold and four Sell.
 

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