On Australian Banks And House Prices

This story features ANZ GROUP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: ANZ

By Greg Peel

Citi notes Australian bank sector share prices are off an average 14% in the past month and 25% in US dollar terms, which is important given the extent of US investment in the Australian market and banking sector in particular. Citi considers this a sufficiently oversold position from which to buy the “Melbourne” banks.

It has thus upgraded ANZ Bank ((ANZ)) to Buy to match its Buy rating on National Bank ((NAB)). The broker retains Hold on both Westpac ((WBC)) and Commonwealth ((CBA)), and has knocked down its target on Westpac from $28.75 to $25.25 to reflect lower interest margins.

Citi suggests the two smaller banks are boasting superior funding profiles and are thus better positioned to participate in the gradual uplift in commercial lending. They also both have lower price/earnings multiples to “defend” than the bigger banks.

All banks will soon need to shift to the international capital requirements of the Basel III accord, but given strong tier one ratios the broker sees those requirements as being comfortably met in Australia. There may even be capital returns once local regulatory changes are confirmed over the next 6-12 months. But with the European crisis now the focus in global credit markets, Citi believes local bank loan to deposit ratios remain too high, meaning a greater need for outside funding. But at a 140% ratio, ANZ and NAB look better positioned than Westpac and CBA on 160%. And the broker notes ANZ's Asian expansion gives it the opportunity to increase deposits offshore.

With underlying earnings growth now considered more of a struggle for the banks as we move further away from the post-GFC rebound, Citi notes that the “reversion of impairment expenses” will become key in earnings growth ahead. This simply means that in the dark days of 2008 each bank took profits aside to park as large provisions against expected bad debts, and while bad debts are always a “long tail” factor out of a downturn, levels to date have appeared to have peaked both earlier and at a lower level than previously expected. So eventually the banks will shift no longer necessary provisions back onto the bottom line and effectively show earnings increases.

Morgan Stanley suggests, however, that such impairment reversion is already priced into bank forecasts, and that elsewhere retail profitability is under threat, there is still too much reliance on offshore funding (echoing Citi's view) and the revenue headwinds are “significant”. Regulatory uncertainty remains and all up, bank valuations look “full” at present, suggests MS.

The broker has nevertheless recently upgraded NAB to Overweight but has now downgraded Westpac to Equal-weight, which puts NAB as Morgan Stanley's first preference over (in descending order) Westpac, ANZ and CBA.

Taking the net Buy/Hold/Sell ratios in the FNArena database gives us ANZ most favoured currently with 6/3/0, CBA next on 5/5/0, then NAB on 4/2/0 and Westpac on 1/7/2. However, four of the database brokers are currently advising NAB so their analysts are restricted from providing a rating. This renders NAB's ratio possibly misleading at this point.

It must also be noted that analysts will likely soon begin a round of general bank target price reductions which won't necessarily come about from any reduction in earnings forecasts. There are two factors to consider. One is that a 14% fall from the peak means a 16% rally from the bottom just to recover the same price (in USD terms, a 25% fall means a 33% rally). The other is that analysts take account of market sentiment in the form of prevailing PE ratios. If sentiment is down, as it has been since the European crisis, then PEs come down and targets soon follow.

In the meantime, UBS analysis suggests momentum in Australia house price increases is nearing a peak, thus suggesting the RBA's rate hikes are beginning to bite.

Housing finance has been falling for six months, notes UBS, although building approvals are still rising. This suggests price growth should begin to slow through the second half of 2010 but actual building numbers should continue to rise (good for retailers of stuff you put in houses). The most immediate indicator of housing strength is the auction clearance rate, the analysts suggest, and it is down but only moderately so. Prices have so far grown strongly but affordability fell rapidly in the first quarter and will likely have fallen sharply again in the second.

UBS also notes sentiment towards the Australian housing market has plunged 40% since last August to 36% below the long term average. The honeymoon of emergency RBA settings is clearly over.

UBS had been forecasting 175,000 housing starts in 2010 and 160,000 in 2011. The analysts have left those numbers unchanged for now, but while 2010 should remain strong they see risks rising for 2011.

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