Banks Still Look Bountiful

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

-Banks attractive despite full valuations
-Solid earnings expected
-Focus for ANZ is on Asian strategy
-Question for Westpac is over dividend
-NAB could still be hamstrung by UK
 

By Eva Brocklehurst

Three of the major banks will publish earnings reports over the next few weeks. In general, brokers believe things are pretty good. Sure, there's no runaway growth but asset quality is improving. Banks may be fully valued on several measures, but attractive yields and few large cap alternatives make the majors, at least, a safe bet. So, what are brokers zooming in on? Impairments, capital and margins.

UBS is expecting a solid season. Earnings growth is expected to be the strongest in some time and industry trends such as mortgage repricing and an easing in deposit competition should support the retail net interest margin. Improved credit spreads should help trading income. The sector is expected to deliver cash earnings growth around 4.9%. Goldman Sachs finds the sector near fully valued but is hesitant about being too negative, given the low relative earnings risk, potential for capital management and stable outlook for long bond yields. 

Delving into ANZ Banking Group ((ANZ)), Morgan Stanley thinks the downside risk to institutional bank margins will be mitigated by retail margins and higher trading income. The second half will be more challenging and the broker is hoping for an update on the Asian strategy. Macquarie is looking for clarity on the Asian businesses too, particularly regarding relative capital allocation between Asia and ANZ's other businesses, including the Asian minority stakes. This is where the broker sees the problem for ANZ. It's the fact these regional segments are not generating a return on equity equivalent to the rest of the business. The broker continues to see stress in parts of the economy and believes it prudent to expect a slight increase in the bank's provisioning, perhaps around 10%. Citi flags the organic capital generation, which appeared in the first quarter, and thinks the bank is a compelling Buy at present levels.

UBS is focused on net interest margins. UBS is the most negative on the FNArena database and has the stock rated a Sell. In contrast to Morgan Stanley, UBS thinks margins will contract, as positive trends from the Australian retail segment are likely to be offset by re-basing and competitive pressures in commercial, New Zealand and international and institutional banking businesses. Deutsche Bank has decided to fine tune a view on the bank ahead of the results, reflecting on the fact that, with the market chasing yield, ANZ could be being penalised for its lower than peer payout ratio. The bank could increase the ratio to 70% from the current 65% and still fully frank the dividend. Based on the FY13 and FY14 forecasts this would increase the dividend yield to 5.6% and 6.0% respectively, which would place it at the top end of peers from a yield perspective.

ANZ has five Buy, two Hold and one Sell rating (UBS) on the FNArena database. The dividend yield on FY13 consensus earnings estimates is 5.0% and for FY14 5.3%. The consensus target price is $28.45, suggesting 4.8% downside to the last share price.

Westpac Banking Corp ((WBC)) may disappoint on institutional bank margins and loan growth in Morgan Stanley's view. The main feature for Westpac is the speculation about dividends and buyback. Morgan Stanley expects a buyback will be announced for dividend reinvestment plan (DRP) shares. According to Citi, Westpac is in the best shape to do this and the bank may at least start neutralising the DRP issuance. No capital returns are anticipated at this stage but a 2c lift in dividend is seen as possible. UBS expects the DRP neutralisation in the first half with a special dividend likely in the second half. Westpac's capital position will be an attention getter for all the right reasons, in this broker's view. This is based on a forecast 16% return on equity, good organic capital generation in the first half and a Basel III harmonised core Tier 1 ratio just under 11%.

For Macquarie, margins will expand from asset re-pricing for all banks and Westpac should benefit the most. Trading income is likely to remain robust and a a source of potential upside from Macquarie's forecasts. The broker also canvases the prospect of a higher than expected dividend but believes it prudent not to pay out capital, given the ongoing global debate on appropriate risk weightings and methodology. Maybe, instead, a special dividend will be forthcoming in the second half. CIMB does not see capital management on the cards, although accepts the bank might neutralise the DRP. The reason is capital ratios look like heading higher. Westpac is now overvalued, in the broker's opinion, given recent share price gains, and has been downgraded to Sell.

Westpac has one Buy, five Hold and two Sell ratings. The dividend yield on consensus earnings estimates is 5.4% for FY13 and 5.5% for FY14. The consensus target price is $29.33, signalling 9.7% downside to the latest share price.

National Australia Bank ((NAB)) may have potential upside for markets and treasury income but margins could be disappointing and UK loan losses could still be higher than forecast, in Morgan Stanley's view. Provisioning is the focus for Citi as well, despite the improving domestic credit quality. More specific to NAB of the three under scrutiny is the significant core banking system replacement that is underway, which carries execution risk. Citi is also mindful of the non-core presence in the UK, which may be divested or scaled up and is, therefore, subject to price/execution risk. Adverse or favourable movements in either of these risk factors may cause NAB's share price to deviate substantially from the target.

Macquarie expects NAB to continue to generate strong capital given the non-core asset run-off. Further progress on the UK book and and further resolution of the exposure to the UK would be welcomed by Macquarie. No spectacular result is expected, just a steady improvement in UBS' view. Again, the UK is cited as the top risk. NAB has been the most aggressive of the majors in the re-pricing of business loans. This may potentially lead to upside for the net interest margin. UBS is forecasting an improvement in bad debts in the half to 48 basis points from the elevated second half FY12 level of 60 bps which included a $250m increase to the collective provision overlay. Nevertheless, legacy UK issues remain a headwind for material improvements in asset quality.

CIMB prefers NAB because the bank is better positioned for structurally lower mortgage credit growth and a cyclical improvement in business credit growth. Goldman Sachs finds UK cumulative provisioning is now more closely aligned with peers in that market and prefers NAB too, expecting the bank to deliver the strongest growth of the three. 

NAB has three Buy, four Hold and one Sell (BA-Merrill Lynch) rating on the database. The dividend yield on consensus earnings estimates for FY13 is 5.7% and for FY14 is 5.9%. The consensus target is $29.95, suggesting 8.6% downside to the last share price.

Commonwealth Bank ((CBA)) will only provide a third quarter trading update on May 15 and Morgan Stanley notes there is some upside risk to forecasts. The broker believes margins and credit quality trends should compensate for ongoing market share loss. CBA has one Buy, three Hold and four Sell ratings. The dividend yield on consensus earnings estimates for FY13 is 5.0% and for FY14 is 5.1%. The consensus target price is $63.28, implying 11.3% downside to the last share price.

No broker finds much to unsettle the banks, provided there are no more global shocks. Nevertheless, UBS is a bit concerned that prices have disconnected from fundamentals, fearing over-extrapolation of the current asset allocation flows, and QE-driven speculative bubbles, may overshadow underlying risks and leverage. Goldman believes the banks do have capacity to start paying special dividends in FY14 but has opted not to include this in forecasts. The broker stresses the need to see capital targets finalised and Level 3 capital requirements from APRA, before doing so. 

ANZ will kick off the season on April 30 with first half results followed by Westpac on May 3. National Australia will report first half results on May 9 and Commonwealth Bank's update is on May 15.

Macquarie Group ((MQG)) will file its FY13 report on May 3. Citi has previewed the results and rates the stock a Sell. While the capital surplus provides some support, the broker believe that ongoing weakness in market business will delay material return on equity improvement, and accordingly, the stock is viewed as trading above fair value. Citi is 5% below consensus for FY13 earnings estimates, primarily due to lower merger & acquisition, and commodities trading expectations. Citi also sees risk of further equity investment impairments, given weakness in small resources over the period.

Citi is the one with a Sell rating on the FNArena database. There are four Hold and two Buy. The consensus dividend yield on FY13 estimates is 4.1% and on FY14 is 5.3%. The consensus earnings forecast is $35.96, suggesting 4.9% downside to the latest share price.

Goldman Sachs expects Macquarie to maintain its strong surplus capital position. What's of interest to the broker is guidance on what management plans to do with excess capital, given the lack of traction the bank has had in this area in FY13.
 

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