ECB Policy A Positive For Australia’s Banks

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-Oz regionals can improve funding costs
-Does CBA have potential for capital return?
-Bells likes ANZ's superior fundamentals
-Morgan Stanley suspects lower NAB pay-out
 

By Eva Brocklehurst

The European Central Bank (ECB) has moved to a negative 0.10% interest rate on deposits held by banks, the first major central bank to do so, in a bid to stimulate lending. This means the ECB will charge banks for holding excess liquidity. In turn, this means that (in theory) banks will look to invest and lend money rather than keep it on reserve. This is not the full equivalent of the recent US quantitative easing (QE), where the US Federal Reserve was actively buying securities to "do what it takes" to tackle deflation, but opens the door, in Macquarie's opinion, for the purchase by the ECB of simple and transparent asset-backed securities.

An upshot of the ECB's decision is that it should generate a strong bid for assets with reasonable yields, which would include offshore wholesale funding and securitisation opportunities which the local banks tap. Hence, the ECB's move is construed as a positive for Australia's banks, particularly regional banks. Large central bank interventions in the market such as that of the US Fed and, now, the ECB, can drive down movements in global spreads and lead to margin improvement for the banks. The average five-year Credit Default Swap spreads for Australia's major banks are in a downwards trend, with Macquarie observing they have reached levels not seen since the middle of 2008.

To Macquarie, Australia's regional banks face a big problem when it comes to funding, as they pay more for the money and have fewer branches to collect funds, while their customer profiles tend to be lower in terms of wealth. Negative interest rates potentially lead to improved funding costs and volumes and the broker thinks, in view of the ECB's decision, the regionals may well prove to have a better outlook than previously thought the case. The broker notes the securitisation market has completed some large deals at good prices recently and this bodes well for an asset class particularly suited to the regional banks. In addition, if the majors continue to tap these markets deposit costs are likely to improve. Macquarie has upgraded Bendigo and Adelaide Bank ((BEN)) recently to Outperform from Neutral on the back of an improved outlook for the regional bank.

Commonwealth Bank's ((CBA)) relative advantage in market penetration and demographics means the major bank is well placed and, combined with excess franking credits, Macquarie believes there is potential for capital to be returned to shareholders in the form off special dividends. Commonwealth Bank may be the best in the class but Macquarie also thinks Westpac ((WBC)) is suffering the least from mortgage pay-down, an ongoing headwind for credit growth in the current low rates, de-leveraging environment.

Bell Potter thinks ANZ Bank ((ANZ)) fundamentals are superior to may of its peers and the exposure to US dollar earnings through its super regional strategy underpins the bank's position at this stage of the economic cycle. Funding costs are easing as the bank steps back from aggressively pricing home loans. The broker also believes the momentum from reducing costs is not spent yet, while there is some way to go before the bad debt charges find a bottom. Hence, some positive surprises are expected in the medium term. Bell Potter has upgraded ANZ's rating to Buy from Hold.

Morgan Stanley recalls that National Australia Bank ((NAB)) lifted its dividend pay-out ratio to 75% in FY12 from 69% in FY11 in order to avoid a reduction in dividends when UK profitability fell. Now that UK loan losses are normalising, and the bank's organic capital generation profile remains modest, the broker thinks a lower pay-out ratio will be warranted. Morgan Stanley expects dividend growth to lag profit growth in FY15 and FY16, with the dividend rising only 2-3% over the next two years versus an average of 6-7% for the other major banks. Moreover, Morgan Stanley does not expect the bank's tier one capital ratio to exceed 9% until FY16, even with slower dividend growth.

Morgan Stanley believes risks are skewed to the downside for Australian banks as trading multiples are full, growth is hard to come by and competition is increasing. Material earnings downgrades may be unlikely, but the broker thinks the potential for a meaningful de-rating of the sector is rising. The broker prefers CBA because of the business mix, geographic mix and cost flexibility. The broker thinks concerns about CBA's capital position and risks to margins from rising home loan competition are over-stated. Westpac is executing on its strategic priorities and this is the broker's next most preferred of the majors. ANZ has a question mark over its ability to meet its FY16 return on equity targets, but this is partly offset by good cost management and the discount to peers, in Morgan Stanley's view.
 

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