Bank Outlook Solid But Can Yields Be Sustained?

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-Healthy dividends but will they hold up?
-Foreign bank commercial expansion
-APRA revisions support regionals

By Eva Brocklehurst

Mortgage re-pricing has revitalised interest in the banking sector in recent months and the sector's strong dividend yields are hard to ignore. Meanwhile, the latest data suggests business credit growth is accelerating and diversifying.

Macquarie believes elevated pay-out ratios are likely to be sustained in an environment of low credit growth and benign credit quality. While ANZ Bank ((ANZ)) offers the highest yield in the sector, albeit with an associated level of near-term earnings risk, Macquarie prefers Westpac ((WBC)), which offers a sustainable dividend yield of 6.0%.

The near-term outlook for the major banks, in the broker's view, is underpinned by a diminished risk of capital raisings in FY16 – which had undermined share prices recently – and supportive revenue trends.

Outside of a substantial deterioration in the credit cycle, Macquarie expects the banks to maintain current dividends despite the fact capital requirements will become more stringent.

Goldman Sachs is cautious about becoming too optimistic about the margin outlook on the back of mortgage re-pricing alone. The broker currently estimate the sector's net interest margin will improve by one basis point in FY16, implying that less than 20% of mortgage re-pricing will be accretive to headline margin. Goldman Sachs also expects deposit pressure to accelerate as cash rates remain lower for longer.

Commonwealth Bank ((CBA)) is considered the most exposed to margin headwinds over FY16, in the broker's view, with National Australia Bank ((NAB)) the least exposed. CBA has also the largest relatively exposure to term deposits. The broker calculates that every 25 basis point decline in term deposit spreads reduces its FY16 margin by around five basis points. The broker's preference is for ANZ, given the upside to its target price.

Morgan Stanley expects the major banks will try to hold the level of their dividends. Still, the differential between the yields of the individual banks has expanded recently, reflecting investor concerns about the risk of cuts to dividends.

The broker argues that ANZ and NAB have less margin for error than the other two majors and rising loan losses against a backdrop of higher capital intensity could trigger a review of dividends in 2016.

The broker suspects the downside risks from these two factors, and an increasing probability that dividends are reduced, more than offsets any benefits of home loan re-pricing. Morgan Stanley retains a relatively negative stance on the banks

The broker has Equal-weight ratings for Westpac, CBA and NAB and an Underweight rating for ANZ. Bank of Queensland ((BOQ)) remains the broker's preferred Australian bank exposure (Overweight), because of an above-peer earnings and dividend growth profile.

UBS observes there is positive momentum in services, transport & storage and retail & wholesale business credit. Growth is also spreading down to small to medium sized enterprises. This pick-up is positive for the banks although the broker acknowledges the data runs contrary to a recent deterioration in capex numbers.

If business credit continues to expand it should support sector revenue, which at 6.0% is the fastest rate of growth since the financial crisis. It also helps offset normalising bad debts and higher share count, UBS maintains.

The broker suspects housing credit growth has peaked at 7.5% and this should ease back to 4.6% in 2016 and 3.4% in 2017. Meanwhile, personal unsecured credit continues to be flat.

Where do the major banks fit in this scenario? UBS observes housing strength continues for ANZ while Westpac has also picked up business. NAB's housing performance appears to have stalled.

Credit Suisse believes housing and business credit growth rates are converging, with business accelerating, albeit unevenly, and investor housing credit growth decelerating. However, what has piqued the broker's interest this month is corporate lending by foreign-owned banks. Market share appears to be on the rise.

Non-Asian foreign banks appear to be driving the trend in foreign bank corporate lending, Credit Suisse observes, with Citi's percentage up to 1.12% from 0.44% and Bank of America to 0.54% from 0.42%.

Asian banks have expanded lending rapidly into the commercial segment of residential and land development. Bank of China has increased its market share to 1.88% in October from 1.55% a year ago. China Construction Bank has increased its share to 0.37% from 0.20% and Mizuho to 1.28% from 1.03% in the same period. DBS now has a market share of 0.07% from virtually nothing a year ago.

The Australian Prudential Regulation Authority (APRA) has published discussion paper on the proposed revisions to its prudential framework for securitisation. One feature, Deutsche Bank notes, is APRA now intends to dispense with a credit risk retention requirement.

This removes a potential downside risk for regional banks, which are heavy issuers of RMBS (residential mortgage-backed securities), as it will allow smaller operators to continue using this capital-efficient funding mechanism.

Currently, APRA permits capital relief for banks issuing RMBS if they sell all tranches, both senior and subordinated. It had proposed deposit taking institutions retain at least 20% of the credit risk of the junior or subordinated class.

The broker believes APRA is taking seriously the recommendations of the Financial System Inquiry relating to competitive dynamics in the banking market. Regional banks are large users of securitisation, accounting for 11% of Bank of Queensland's total funding and 8.0% of Bendigo & Adelaide Bank's ((BEN)). This compares with the major banks usage at around 2.0%.
 

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