Brokers Turning On The Banks

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

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

On the morning before the RBA meeting this week, National Australia Bank ((NAB)) announced it would not lift its standard variable home loan rate above the level of any increase in the cash rate. NAB has been trying to win back some lost mortgage market share.

Given ongoing warnings from all banks lately that funding costs continue to rise, NAB might have been hoping its preemptive declaration would put it in good competitive stead with borrowers. But then all of the remaining Big Four banks later raised their own SVRs by only the same 25 basis points as the RBA.

This capitulation is in contrast to earlier months when quite substantial independent increases were added to SVRs by some banks in order to cover some of the funding gap. Banks' peak of loan maturity is around four years, and funding rollovers are stepping into GFC-impacted territory – not nearly as expensive as they were at one point, but still more expensive than they were four years ago.

So why are the banks suddenly so accommodating?

Because it's an election year – that's why. One can envisage the smoke coming out of Wayne Swan's ears if the banks had tried to go to 30 or more basis points on home loans, even if it would have been all for show on his part. Joe Hockey would have tried to pretend he knew what he was talking about too. The fact of the matter is that banking regulations are currently under review across the globe and no one expects potential changes to favour the pragmatically sensible over the politically popular. In other words, bank CEOs are currently tip-toeing around on eggshells.

As the Macquarie analysts put it this morning, “Tighter liquidity standards are likely to result in around 5 basis points of net interest margin pressure over FY10-11 as a result of more aggressive stress testing and stable funding requirements”. In other words, the government will come down on the banks with the GFC as the excuse and force a skinnier margin between bank borrowing and lending rates.

This is one reason why Macquarie sees limited scope for further bank outperformance from here. The market may be expecting a V-shaped bounce in non-mortgage loan growth in FY11, but that's already priced in. Capital adequacy looks sufficient since the post-GFC capital raising orgy but there remains some doubt of what will or won't qualify as tier one capital among the many and varied hybrid debt/equity issues on the banks' books.

This means capital management remains under a cloud, so buybacks or special dividends are off the agenda.

Moreover, the February round of bank updates featured a more rapid turning around of bad debt expectations than the market had forecast. The numbers have also now been adjusted on that front so there is less chance for any more positive surprise.

So what is left to drive bank share prices higher from here?

The following table notes the recommendations and average share price targets of the FNArena database brokers. With the exception of an underperforming NAB, share prices have rapidly closed in on those averages (as at yesterday's close). While experience suggests prices can exceed targets for a period, something then always has to give. Either brokers are forced to raise their targets or share prices have to turn. More often, the latter occurs. And Macquarie's argument suggests targets aren't likely to rise much from here.

Indeed, Citi this morning downgraded ANZ Bank ((ANZ)) from Buy to Hold given the share price had reached the analysts' target of $25.50 after a strong three month run.

Macquarie downgraded Westpac ((WBC)) from Outperform to Neutral and already has a Neutral rating on ANZ. The broker is currently restricted on making a recommendation for NAB. Macquarie believes Westpac is now fully valued, even using FY12 forecasts.

But Macquarie is bucking the trend by being rather keen on Commonwealth Bank ((CBA)). The analysts today lifted their target on CBA from $60.53 to $66.50, creating a huge gap to low marker Deutsche Bank on $52.00. With the target price jump came an upgrade to Outperform.

As the table above suggests, it is a lonely group of brokers who believe CBA still offers value despite trading at a significant premium to the other three majors. Either one believes that because of size, reputation and penetration CBA deserves such a premium, or one simply believes CBA is out of whack with the rest of the sector on market euphoria.

Morgan Stanley (not in the FNArena database) currently has an Underweight rating on CBA and this morning offered its opinion on what would have to change for the analysts' to change their minds.

MS believes CBA is fully priced unless it can lift its loan rates (and as discussed earlier, that ain't gonna happen), reduce its loan loss charges further than expected (BankWest is the problem here), or rationalise its “core banking” business by reducing costs through modernisation.

The latter is already a strategy that is underway, so good results here could be a swing factor that makes a difference. But in the meantime Morgan Stanley does not see upside for CBA, while seven of ten FNArena database brokers are comfortable on Hold ratings.

Today's bank analyst dissertations come hot on the heels of a report released last week by RBS in which the broker questioned the aforementioned V-bounce in total credit. RBS believes its peers have become too carried away and that a return to strength in business lending is a long way off yet. (See Australian Banks Overpriced, Except Perhaps For NAB)

See also "Rudi's View: The Return Of The Bank Stocks Market Indicator" published earlier today.

Note: the small differences between the consensus price targets in the table and those on display in Stock Analysis on the website are due to the inclusion/exclusion of GSJB Were.

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