Tag Archives: Banks

article 3 months old

Weekly Broker Wrap: Insurance, Telecoms And Supermarkets

-Positive outlook for Medibank Private
-IAG and SUN losing market share
-Interest may switch to telco access providers
-IIN may be vulnerable to access reform
-MTS likely the biggest loser to discounters
 

By Eva Brocklehurst

Morningstar believes Medibank Private, Australia's largest provider of health insurance and owned by the government, will be attractive to investors. The business is to be sold via an initial public offer (IPO). Pricing is yet to be determined but, given the government's eagerness to sell the asset, it should be keen. Assuming a realistic issue price and no negative surprises in the prospectus the researcher believes demand for the stock should be healthy, given successful recent floats and a dearth of attractively priced, high quality defensive investment opportunities. Based on the long-term outlook for the private health insurance industry and research on listed competitor, nib Holdings ((NHF)), Morningstar is positive about the industry. Government regulated pricing and risk sharing across the industry limits earnings upside but also create a floor for minimum profitability.

***

Insurance Australia ((IAG)) and Suncorp ((SUN)) are likely to sustain a period of flat top line growth, in Morgan Stanley's view. The two are being tested by challengers. IAG's personal lines franchise is likely to prove more durable than Suncorp's, the broker suspects. Challengers to the major's franchises are growing their market share in motor and home insurance, building consumer brand awareness. Youi is now number three in motor insurance, with a 4% share. it has a 5% share of home insurance.

The challengers are seemingly more intent on making Suncorp customers switch brands. The price is less of a factor for IAG customers, in the broker's analysis, as they shop around less and it takes a bigger discount for them to switch. Suncorp customers tend to shop around more. Both insurers have been growing below system in the home and motor insurance markets over the past three years. Morgan Stanley suggests customer retention is the key for IAG while Suncorp needs volume.

UBS is cautious about the general insurance sector as the major insurers attempt to address market share losses. The market shares of Suncorp and IAG have slipped again over the second half of FY14. Both lost 1.0% in motor insurance share and almost that amount in home. UBS acknowledges the success in the general insurers over recent years in widening underlying margins is commendable, as margin usually wins over growth on the day. Still, market share losses are mounting and are now at odds with another mantra to "at least hold share and manage margins". The broker observes, had the majors maintained the market share in motor and home they held four years ago when the challengers started to make inroads, their collective premia base would be almost $700m higher - Suncorp at $390m and IAG at $285m. 

***

Draft recommendations from the Harper Competition Policy Review have significant implications for the telecommunications sector, in Morgans' view. One is the onus on those seeking access to infrastructure - resellers - to show proof of a public benefit. There is also the recommendation of a specialist access and pricing regulator separate from the ACCC. Morgans believes the proposals are likely to have a significant impact on shaping investment returns and improving productivity across the fixed line telco sector. Moreover, the recommendations are part of a set of developments that are likely to swing investor interest back towards access providers and return the purpose of access regulation to supporting an appropriate balance between efficient infrastructure and competition.

Reform of the access regime may come too late to preserve much of the value in Telstra's ((TLS)) copper network, in the analysts' view. TPG Telecom's ((TPM)) competitive advantage may be underpinned by the reintroduction of infrastructure competition but substantial changes are not expected before 2016. Of the providers, iiNet ((IIN)) has the most commitment, perhaps over-commitment Morgans suspects, to the existing NBN model, and it would need to regroup substantially to remain a viable carrier in a more competitive framework. The other main player, M2 Telecommunications ((MTU)), is the purest reseller but has other areas that may help it manage changes in the way value is created.

***

The grocery discounters, Aldi and Costco, are becoming more of a threat to the sales and margins of the major supermarket chains in Australia. UBS takes a look at whether Australia will go down the path of the UK, where traditional chains have been negatively affected by new entrants, with the growth in the discounters accelerating in the past four years and now occupying a market share of 9%. A high penetration of private labels and a willingness to try new channels aided acceptance of the new brands in the UK and the broker suspects Australia will be no different. The discounters are also winning a share in UK fresh food and are no longer viewed as cheap alternatives.

How relevant is this to Australia's supermarkets? UBS notes Aldi already has more market share in Australia, at 6%, than it does in the UK, at 5%. Given higher margins in Australia versus offshore peers, Aldi Australia may have even greater opportunity. UBS believes the margins of Australia's major supermarkets are under greater risk than their sales volumes, based on the UK experience, and they need to regain shopper trust to moderate the Aldi threat. The independents, such as the IGAs, supplied by Metcash ((MTS)), are a more significant part of the Australian landscape, in both fresh and full supermarket channels compared with the UK, where independents are virtually extinct.

UBS suspects IGAs will be the main casualties of the newcomers and insulate the threat to Coles ((WES)) and Woolworths ((WOW)) in the near term. The broker has downgraded forecasts for Metcash as a result, reducing its recommendation to Sell from Neutral.
 

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article 3 months old

Brokers Ponder Regulatory Curbs On Major Banks

-Cap on debt servicing ratios possible
-Raising of mortgage risk weights likely
-Majors will need to raise more capital
 

By Eva Brocklehurst

The Reserve Bank of Australia has made its concerns known regarding the investor mortgage market in its semi-annual Financial Stability Review (FSR). What is the most likely course of action the central bank could take to address those concerns? The RBA is looking at whether bank mortgage lending practices are sufficiently conservative in the current environment of low interest rates, strong house price inflation and higher household indebtedness. The issue for central banks in such an environment is how to curb asset price inflation but avoid shutting down a broader economic recovery by raising official interest rates.

Credit Suisse suspects the most likely tool in the RBA's arsenal is a cap on Debt Servicing Ratios (DSR). That is, tightening the income requirement needed to service mortgage interest payments. The RBA appears to view a DSR cap as a relatively well targeted measure, as it allows lower cash rates to feed into lower mortgage servicing costs but not into increases in the size of the mortgage. That would constrain lenders with regard to domestic borrowers but what about foreign investors? The central bank appears to consider a solution regarding foreign investors lies outside its powers, such as with tax, foreign investment and housing supply policies. The RBA has stated that, over time, it should be within Australia's capacity to meet demand from both foreign investors as well as Australian citizens for new housing.

The RBA is discussing options with other regulators including the Australian Prudential Regulation Authority (APRA), which released a draft prudential practice guide on residential mortgage lending back in May. The guide elaborates on APRA's expectations for lenders with regards to risk management, loan origination and security valuation. This suggests two things to Citi: firstly that some targeted macro prudential type of instrument for the investor segment cannot be ruled out and secondly, that a cash rate increase (RBA's responsibility) is not one of the options being considered.

UBS concurs, regarding the conclusions about the consultation with APRA, noting the RBA's FSR was a warning shot across the bows. What is not exactly clear to the broker is whether the RBA is warning that if the market does not slow more action will be taken, or whether steps are required immediately. The RBA does not specify measures, but UBS believes it would tend towards traditional macro prudential tools, such as interest rate tests or counter cyclical capital buffers, rather than New Zealand-style loan-to-volume ratio rules. What is important is that the central bank has revealed some preference for targeted measures against "unbalanced' housing activity rather than broader cash rate hikes. The broker acknowledges this creates some risks for its forecasts for a rate hike in mid 2015, suggesting the timing might be too early.

In parallel with the growing concerns raised by the RBA over the housing market there is the Financial System Inquiry being conducted into capital requirements for the major banks. The Murray Inquiry is due to deliver its final recommendations in November. Credit Suisse believes introducing mortgage risk weights for the big banks could constrain, at the margin, the participation in mortgage finance by the major banks but implementation could take some time. This brings the broker back to the DSR cap as the RBA's most likely option.

Morgan Stanley believes the Murray Inquiry will recommend that capital requirements be revised to enhance financial stability and help restore competitive neutrality in the mortgage market. The broker expects higher minimum capital ratios and an increase in mortgage risk weights. APRA is expected to require major banks to meet more onerous capital requirements over the next few years.

How do the major banks line up in regard to the implications from the regulators' mortgage market concerns? Morgan Stanley assumes the major banks will use their dividend reinvestment plans (DRPs) to meet the new targets by the end of 2017. The alternative is large share placements in 2015. Furthermore, the broker believes National Australia Bank's ((NAB)) new leadership may justify a capital raising at the bank's FY14 result, irrespective of the Murray Inquiry's potential outcome. The majors may not want to pre-empt the conclusions, but recent comments from the inquiry panel and APRA suggests the banks will ultimately need to hold more capital.

Credit Suisse believes the majors, ex Commonwealth Bank ((CBA)), will need to raise capital to meet prospective capital requirements, with NAB the more vulnerable. Any requirement for more weighting on mortgage risk - such as that envisaged above, results in additional capital requirements for each major bank. Credit Suisse does not believe organic capital generation, or DRPs, will be enough. Only CBA is able to accumulate sufficient additional capital over three years merely by using nil discount DRPs, while the other three will face shortfalls.

Other options for the banks include immediate sale of non-core assets, such as NAB's Great Western, Clydesdale or UK CRE and, to a lesser extent, ANZ Bank's ((ANZ)) Panin Bank investment. Raising capital up front to immediately enhance flexibility could be particularly effective for both NAB and ANZ. In fact, Credit Suisse argues such an initiative from these two could leave CBA sidelined and vulnerable to share price underperformance as it organically accumulates capital.

Where does the fourth major, Westpac ((WBC)) fit into the scenario? Well, if the Murray Inquiry's recommendations skew more towards mortgage risk weighting then Westpac is the most affected major bank, although it would result in additional capital requirements for each of the majors. The other in the likely spectrum of recommendations is based on the framework established in Basel III for dealing with Domestic Systemically Important Banks (D-SIBs). If the recommendations skew more to additional charges on this basis then the scenario is relatively more burdensome for ANZ and NAB. Brokers suspect the recommendations will involve a combination of both mortgage risk weighting and D-SIBs measures.
 

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article 3 months old

The Bank Yield Plays Will Keep Yielding

By Peter Switzer, Switzer Super Report

There's a whole lot of banking bashing around at the moment but it does depend on who you are. If you're a wealth accumulator, you might be a bank seller but you'll have to work out your profit versus your capital gains tax implication.

However, if you're a bank buyer for the dividends primarily and have been happy to collect the capital gain, then you might just as well cop the dive in share prices and buy again when they get even lower.

The future for banks

I say this because I reckon bank share prices will recover but they might not go as high as you would hope.

The very smart Charlie Aitken put together a very thoughtful case of why he went to "neutral or hold" on banks in April and now has gone underweight.

In a nutshell, the US interest rates are set to rise and the Fed will be halting money supply increases with the end of QE3, which will push up the greenback and lower the Australian dollar.

It's why our stock market has been falling with the dollar and it's because foreigners, who chased yield stocks, are now selling out. Taking their money home if you like and they might buy US bonds instead.

They are also fearful of holding Aussie shares, which will be less valuable when they sell out of them and convert the dough into US dollars. The longer they wait, the greater the amounts they could lose.

Charlie says foreigners don't get franking credit benefits and so they are less addicted to our yield stocks. But he did accept that they might return one day when they think the dollar has hit rock bottom.

Why would they return to our banks? Because they are damn good investments backed by a government guarantee that some nutcases want to take away! I really hope David Murray, who is a mate, doesn't buy this bull dust.

We survived the GFC without a recession and 10% unemployment because the ratings agencies saw our banks as some of the safest in the world. It kept our borrowing costs down, and it still does, and in part explains why we have an economy that has avoided a recession for 23 years.

Canada is toying with changing its government backing of its banks and the debt rating agencies are thinking about downgrading them.

In a recent SMH article, the Macquarie analyst Mike Wiblin said "a credit rating downgrade would push up the cost of Australian banks' borrowing overseas, inflicting a hit to earnings of between 3% and 5%."

This is why I hope David ignores the ‘experts', who don't like the banks being backed by the government. My argument is that the government support means lower interest rates, more growth, more jobs, more confidence and if it ain't broke, why fix it?

And given the benefits, it's one of the reasons why I think our big banks remain a good investment, especially at lower prices.

The advantages

I think our economy is getting better. Eventually, interest rates will rise and that does not hurt bank profits. They are such monoliths in our economy, I just can't see them screwing up their advantages.

Only 11 months ago, Morningstar said this of our banks: "Australia's largest four banks dominate an oligopoly that gives them a durable structural competitive advantage, ensuring they'll earn excess returns over the very long term. This enables the banks to prosper compared with major banks elsewhere in the world and gives Morningstar's analysts confidence that the banks will have global sector-leading returns on equity for the foreseeable future."

Morningstar said the banks have an "economic moat", which is a "sustainable competitive advantage that allows a firm to generate positive economic profits for the benefit of its owners for an extended period of time."

What advantages? Try scale advantages, cost advantages, efficiency advantages, investment advantages, capital advantages, funding advantages and competitive advantages. Oh yes, government support advantages.

In only February, the SMH reported that: "Australia's banking sector has been rated one of the five safest in the world as profits soar and bad debts decline."

But there was more.

"We believe that Australia is currently one of the five least-risky banking systems of the 86 for which Standard & Poor's has published banking industry country risk assessments," S&P credit analyst Gavin Gunning said.

"Our most likely scenario for 2014 is that it will be a year of continuing investment-grade ratings resilience."

The other safe places to bank were Switzerland, Canada, Germany and Hong Kong.

All this tells me that, provided the world economy does OK (the G20 finance ministers last weekend said they're trying to push up global growth by 2% over five years) and our economy grows stronger (which I expect), I think banks remain an OK investment.

What I'm doing

When it comes to my own investments, I play a more steady accumulation game based on yield. I don't care if my capital fluctuates because it eventually comes back. If I really can see a crash coming, I'd cash out. Of course, that's not always easy to spot, though I'm permanently on crash alert. That's my gig at the Switzer Super Report.

The other part of my gig is to spot value for yield players. Banks at lower share prices, which will eventually go higher when foreign investors return, look like an OK play and I'll be playing it!


Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

Content included in this article is not by association the view of FNArena (see our disclaimer).

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual's objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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article 3 months old

Weekly Broker Wrap: Banks, Advertising, Wages And Energy Retailing

-CBA's deposit base stands out
-Advertising reliant on retail
-Risks for consumption growth
-Snowy Hydro privatisation?
 

By Eva Brocklehurst

Macquarie's analysis of Australian banks reveals Commonwealth Bank's ((CBA)) deposit base delivers $935m in profit and the bank remains a clear leader over its closest peer, Westpac  ((WBC)), at $550m. As a result CBA remains the broker's top pick. ANZ Bank ((ANZ)) has a retail deposit base around half that of CBA but its customers do have higher average balances, leading to an overall profit per deposit customer that heads the sector. ANZ also has more exposure to the older de-leveraging demographic segments, while softer credit growth in Victoria stands the bank in good stead from a deposit growth perspective. The broker retains an Underperform rating on ANZ given concerns around Asian exposure.

Of most concern to Macquarie is Westpac's lower quality customer base. Westpac appears to have favourable deposit trends but is less competitive on savings account considerations. Hence, Macquarie has recently downgraded to Neutral from Outperform. National Australia Bank's ((NAB)) deposit base is the smallest by value but it does have the largest average balance by customer. To complicate the picture, NAB also has the lowest share of wallet and lowest spread, in that it pays more for deposits than the other majors. In a similar way to Westpac, Macquarie expects idiosyncratic factors to dominate NAB's deposit growth outlook. The broker does acknowledge other positive catalysts for NAB around divestment and the restoration of domestic business momentum.

***

Media agency bookings indicate the advertising market in the first half of FY15 is flat to slightly weaker, with August down by around 3%, primarily because of comparisons with last year's spending on the federal election, a benefit largely captured by TV. JP Morgan considers the underlying market is weak. The most positive aspect in the data was that retail, the largest media spending category, grew 3.2% in August, reversing recent weakness. Metro TV spending declined by 6.0% and the structurally challenged newspaper and magazine sectors declined by 14.5% and 16.1% respectively. Digital advertising spending grew 5.7% in the month. JP Morgan expects first half FY15 growth will be reliant on the fourth quarter of 2014 for growth, particularly in retail, which contributes around 20% of total advertising expenditure.

***

Wages growth slowed sharply over FY14, with household average earnings just 1.5% higher year on year, the weakest growth since the late 1990s. This is well below the pace consistent with UBS' consumption forecast of 3% growth for 2015. While UBS acknowledges slower wages growth is good for company profits, it can also depress economy-wide demand, ultimately worsening both profitability and the ability to invest. In the broker's view it will boil down to inflation outcomes, and whether lower inflation is enough to deliver a boost to consumer spending and ultimately support profits and jobs.

UBS finds that companies with the greatest potential to benefit from slower wages growth are those in which the wages bill is a significant share of profits, but also where there has been less reduction in wages growth so far. These sectors include administration and support, manufacturing, accommodation, food and construction. The broker still expects real household disposable income to rise 2.5% over the coming year, helped by lower inflation and a pick-up in employment. Despite this, a further draw-down in household savings rates will be needed to meet the forecast of a 3% pace in consumption growth in 2015. At present, the broker concedes, the risk is for under achieving on that forecast.

***

Snowy Hydro has purchased Lumo Energy for $605m. The acquisition includes around 540,000 customers, mainly in Victoria, as well as 163MW in diesel peaking plant in South Australia and Direct Connect, a customer acquisition channel. Deutsche Bank had anticipated Lumo Energy would be sold but both the value and acquirer were surprising. In the broker's view, the transaction metrics are supportive of an improving retail outlook and further vertical integration appears consistent with the recent report to the federal government recommending the privatisation of Snowy Hydro.

Deutsche Bank is adamant that irrational competition for market share by small players has blighted energy retailing and consolidation should improve sustainability. Given energy retailing is highly scalable, the industry has endured significant discounting in order for small players to obtain market share and this has increased churn and compressed margins. Consolidation is therefore considered a positive for the listed players such as AGL Energy (((AGK)) and Origin Energy ((ORG)).

The three government owners of Snowy Hydro, NSW, Victoria and the Commonwealth tried unsuccessfully to privatise the business in 2006. Deutsche Bank believes recent developments appear to support increased vertical integration as a way to privatisation. The deal makes sense to Citi too. The broker believes the price of Lumo Energy was too rich for most tier two players in the market, which lack sufficient balance sheet capacity, while the top two, AGL and Origin, were probably restricted by competition concerns.

Citi also notes Snowy Hydro has stated a desire to be the fourth pillar of competition in the market, which suggests a listing or sale to a new entrant is more likely than a sale to an existing player. The broker does not envisage a large change in the NSW or Victorian landscape until Snowy Hydro obtains base load generation, unless customer growth becomes a focus. However, the addition of peaking generation in South Australia could allow the company to compete harder for new customers.
 

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article 3 months old

More Downside For The Banks


[Note: The chart above and analysis below refer to the ASX Financials ex-REITs sector index, the XXJ. Given the significant net market cap weighting of Commonwealth Bank ((CBA)), Westpac ((WBC)), National Bank ((NAB)) and ANZ Bank ((ANZ)) within the XXJ, this sector index acts as a proxy for Australia's Big Four majors, or as we tend to say in Australian stock market parlance, "the banks" - Ed]

Bottom Line 17/09/14

Daily Trend: Neutral
Weekly Trend: Up
Monthly Trend: Up
Support levels: 7024 / 6797 / 6430
Resistance levels: 7460 / 7883

Technical Discussion

Our headline last month was “Short term weakness anticipated” and although that was the case buyers once again stepped in to support price.  The end result was yet another significant high being locked in.  However, the sell-off over the past week or so has been strong, albeit only over the shorter time frame.  A decline of just over 5% in a couple of weeks is about as bad as it’s been for the Banking sector over recent times.  A very similar thing occurred at the end of July so there’s no reason to be hitting the panic buttons quite yet but there is room for further weakness over the coming weeks.  We’ll discuss further in the technical section below.  One reason for the current pull-back is likely overseas investors pulling out of higher yielding stocks.  There are growing concerns regarding [Australian] interest rates which may well need to be cut again.  This in turn means foreign investors will have exposure to currency weakness.  The end result is that the likes of Telstra and the big banks are coming under pressure.

Reasons to be aligned to the Sector longer term:
→ Interest rates should remain lower for longer due to recent inflation data.
→ The Banking Sector continues to be the driving force behind broader market strength.
→ The longer term trend is exceptionally strong.

The bearish divergence on the weekly time frame we’ve been harping on about for what seems like an eternity is finally proving to be significant.  It’s also triggered on the XJO [ASX200] though in this instance our oscillator is well on its way to hitting the oversold position.  In fact it’s around two thirds of the way to doing just that.  At the present rate of knots a couple of weeks could be all it takes for the divergence to be a thing of the past.  Back to the chart shows that the XXJ is sitting pretty much where it was back in May 2013 with a sideways consolidation taking hold.  The minor line of support was breached today by the slimmest of margins which paves the way for price to rotate down toward our target zone.  The target is simply the 50% - 61.8% retracement zone of the prior leg.  As long as the lower boundary at 6797 isn’t penetrated the bullish longer term case remains intact.  If it is breached a more substantial retracement is going to take hold, with the low made in February around 6400 being the next target.  One thing we have to remember is that it’s been an almost straight line rise since 2012 meaning a more significant retracement is not only feasible but also healthy.  First of all let’s see how price reacts over the next few days and whether buyers step in around this minor line of support.

Trading Strategy

Until the bearish divergence unwinds we need to be very sceptical of any short term bounce, especially if it’s coupled with decreasing volume.  On the positive side of things recent weakness has been coupled with relatively low volume which is another reason why we shouldn’t be overly concerned in regard to something much more sinister unfolding.  Should today’s low be overcome the typical retracement zone as shown should be the next port of call, possibly presenting a buying opportunity though we’ll discuss that in more detail nearer the time. 
 

Re-published with permission of the publisher. www.thechartist.com.au All copyright remains with the publisher. The above views expressed are not by association FNArena's (see our disclaimer).

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article 3 months old

Australian Stocks: What Happened Today?

By Chris Weston, IG Markets

Asia has been fairly subdued, which is expected given the magnitude of the overnight risk event, although the same can’t be said for the ASX 200 which has been sold off fairly aggressively .

The reaction in US trade to the speculation that the People’s Bank of China was planning to inject RMB500 billion (US$84 billion) into the five largest commercial banks may have been initially met with good buying in bloc currencies, copper and A50 futures, however Asia-based traders have been more measured.

There will be an increase in base money (QE) and by all accounts the speculated measures equate to a reserve requirement ratio cut of 50 basis points, however when the dust settles we know the facility is limited in time and likely to be rolled back in three months. Liquidity is always well received by markets and the fact Chinese financials have moved higher is testament to this. However, banks are still constrained by the cap on loan-to-deposit ratios (of 75%) and thus these measures are not going to promote the necessary boost to industrial production needed to see 7.5% in Q3. I imagine given the fourth Plenary and Shanghai-Hong Kong through connect in the coming month that we will see more of these types of initiatives from the PBOC.

Traders have generally faded the overnight AUD/USD move today and what’s interesting is the price action in the ASX 200. After a pop on the open, traders came straight in and sold financials. What’s more, volumes have been strong and at 13:15 AEST turnover was 44% above the 10-day average and 36% above the 30-day average. The 2012 uptrend and 200-day moving average at 5415 and 5417 respectively has given way, although the bulls will take heart that on a daily perspective this market is oversold.

Australian banks sold aggressively

The fact that all the selling has centred on the banks has been interesting; while we have seen a downgrade to Westpac (by Macquarie), this wouldn’t explain the moves [for National Bank, ANZ Bank and Commonwealth Bank]. There have been some concerns around Australian housing over the last few days which would certainly play into the moves, while the idea that in reality the Federal Reserve will lift rates at some stage, and thus income strategies that have done well with the Fed keeping rates low amid record low volatility are beginning to unwind. Whether much of the selling is offshore has been widely debated and perhaps we may even see a few funds shorting the banks again, which of course gets speculated from time-to-time.

Japan has been side-lined today and thus US futures are not really giving too much away. Our European equity market calls are positive, but it’s hard to see too much money being put to work, ahead the Fed meeting  and Janet Yellen’s press conference 30 minutes later. Further focus will fall on the Scottish referendum, however all three polls seen through European and US trade portrayed a similar story that Scotland should remain in the United Kingdom. It still concerns me just how under-positioned the market is for a ‘yes’ vote and rates markets have barely moved through the intense reporting. Bank of England minutes will also be in play; however we shouldn’t see any new board dissent.

The Fed unlikely to move the dial too greatly

The Wall Street Journal’s Jon Hilsenrath article detailed that he believes the Fed may refrain from deviating from its ‘considerable period’ language, but the language will be qualified and has been widely discussed on trading floors today. However, strategists’ views on a change of language are more mixed, and Mr Hilsenrath has been accurate in the past and new positioning today has back his judgment. The Fed’s first ever projections around the Fed funds rate in 2017 will be interesting and I would expect the median projection to be around 3.5%, while traders will also be keen to see if the 2015 and 2016 views will be amended closer to current market projections.

We have seen a number of regional presidents calling for earlier hikes of late, but core members have yet to follow. Nothing has really changed from recent meetings in terms of inflation and wages, so it’s easy to align oneself with Mr Hilsenrath’s view. Still, there is simply too many variables that need to be taken into consideration to get a clear cut view of how markets may move, and as always the first move may not be the right move.


Reprinted with permission of the publisher. Content included in this article is not by association the view of FNArena (see our disclaimer).

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This material does not contain (and should not be construed as containing) financial advice, recommendations, opinions in relation to acquiring, holding or disposing of a CFD, or a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG is not a financial adviser and all services are provided on an execution only basis. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of the above information. Consequently any person acting on it does so entirely at his or her own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. This communication must not be reproduced or further distributed. Issued by IG Markets Limited 84 099 019 851, AFSL 220440.

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article 3 months old

Macquarie Rakes In Higher Fees

-Mixed outlook prevails
-Further upside in fees
-Tail wind from lower AUD
 

By Eva Brocklehurst

Macquarie Group ((MQG)) will crystallise significant performance fees in FY15, leading to an upgrade to guidance. The financial conglomerate has guided to FY15 being "slightly up on FY14" after previously signalling earnings would be "broadly in line". Moreover, first half results - when the fees will be accounted - are likely to be 25-30% higher than the prior corresponding half, while second half earnings will only be modestly higher than the first half.

Despite confirmation of higher performance fees, JP Morgan believes subdued market volatility will be an obstacle to securities and Fixed Income, Currency and Commodity (FICC) trading revenue, capping the uplift from not just higher fees but also deal activity and growth in domestic mortgages. UBS envisages further upside from higher performance fees and, following a share price pullback, views the stock as more attractive. However, should the financial system inquiry recommend higher capital levels, there may be pressure on Macquarie to strengthen capital ratios, given its surplus has been run down. Both brokers err on the side of caution and retain Neutral ratings.

Most brokers believe the increase in performance fees primarily relates to the Macquarie European Infrastructure Fund 1 (MEIF-1). This unlisted fund is in its asset realisation phase as it reaches maturity. In recent months the fund has sold down stakes in APRR - French toll roads - and Arlanda Express - Stockholm airport connection. From an accounting perspective, Macquarie can now reliably measure the fund valuation and book performance fees. As the rest of this portfolio is sold down over the next 18 months further performance fees are highly likely. UBS would not be surprised to find the performance fees from the fund settle in the hundreds of millions of dollars, given the rally in bonds over the life of the fund and strong underlying asset performances.

Outside of performance fees there were were no changes to forecasts for other businesses and UBS expects another cold North American winter may be required for FICC income to repeat its stellar performance at the end of FY14.  Credit Suisse also observes Macquarie's earnings in recent years have been seasonally higher in the second half, reflecting the FICC leverage to the northern winter through the energy trading business as well as through asset realisations in metals and energy.

The residual MEIF-1 and other unlisted funds approaching their 10-year life should underpin the stronger trend in performance fees, in Credit Suisse's view. The broker makes the point that performance fees are not "one-off". Performance fees have been reported by Macquarie every half year for the last 12 years. The issue is whether they are bigger than usual.  Many of the Macquarie unlisted specialist funds are 10-year closed-end funds, although the broker understands that few have reached maturity and been wound up - the trigger for performance fees. Credit Suisse observes that Macquarie's fee structures and fund performance measures are quite opaque. The broker is also challenged in quantifying what the company's guidance actually means. Historically, the guidance statements are very broadly interpreted by the company with result variations of 10% still considered to be "broadly in line".

The upgrade to guidance is well and good, but Deutsche Bank sticks with a Hold rating and believes the stock is unlikely to re-rate until market conditions turn around. The broker's forecasts prior to the update already reflected the additional contribution from MEIF-1 and assumed some market recovery. Performance fees aside, transaction volumes are soft and continue to affect the market-leveraged franchises, in the broker's view.

For BA-Merrill Lynch the message from the guidance upgrade is that the business can more than offset the FY14 gain from the Sydney Airport ((SYD)) distribution. Rather than focusing on soft transaction volumes, Merrills considers capital markets momentum has been strong and this should extend well beyond the 10% impact from higher advisory revenue. Hence, scope for asset realisations and performance fees rises significantly. The broker believes the expectation for second half profit to be only moderately above the first half is based on conservative assumptions for FICC income and retains a Buy rating. Merrills also notes the fall in the Australian dollar will deliver a tailwind for Macquarie, given its significant offshore exposure. The broker calculates that every 10% fall in the currency it delivers a 7% impetus to Macquarie's earnings.

Macquarie attracts three Buy ratings and four Hold on the FNArena database. The consensus target price is $60.48, suggesting 2.8% upside to the last share price. Targets range from $54.52 (JP Morgan) to $65.85 (BA-ML). The dividend yield on FY15 forecasts is 5.1% and FY16 is 5.8%. 
 

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article 3 months old

Emerging Sell In ANZ

By Nick Linton-Ffrost

Emerging Sell

We suspect ANZ Bank ((ANZ)) has formed a near term topping pattern between 33.20 and 33.70 which implies a decline towards 32.40 over the next week or two.

Our view is based on the assumption that ANZ has formed a H/S top and has completed the “b” wave within a structure which is correcting the rally from 32.30 to 33.80.

We suggest opening short positions given a lower high has formed at 33.45. Trading above 33.50 for more than a few days negates our view.

Trading tactics

Open shorts using a 33.20 limit placing stops at 33.55 and looking for a move to 32.40.
 


Another trading idea from

Fifth Wave | fwtc.com.au                                               

FW generates over 150 Trading Alerts on the ASX100 each year. We are a subscription service specialising in short term technical strategies based on 27years experience.

 AFSL 319830 | Disclaimer

Reprinted with permission of the publisher. Content included in this article is not by association the view of FNArena (see our disclaimer).

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article 3 months old

Weekly Broker Wrap: Equity Strategies, Insurers, Electronics and Online

-Risks rising for banks, A-REITs
-Deutsche Bank likes yield & growth
-Lower insurer losses, lower risk cost
-Increased inventory, risk in electronics
-Online shares rise, so should earnings
 

By Eva Brocklehurst

One of the surprises this year has been the overall decline in US bond yields, even as the Federal Reserve has wound down purchases of securities. Citi observes, in terms of equities, this sustains investment in the Australian banks, real estate investment trusts (REITs) and other interest-rate sensitive sectors. Still, it may not be the case for long. The broker suspects upward pressure on yields may be building as a number of indicators show a further strengthening in the US economy. To this end short-term US Treasury yields continue to trend higher, resulting in a flattening of the yield curve. All these indicators suggest to Citi that risks may be rising in the Australian equity market for banks, A-REITs, utilities and infrastructure stocks thus trimming weightings in these areas may be a prudent move.

Deutsche Bank's strategists suggest interest rates could nevertheless remain lower for longer and this should support equity investments. Profits are unlikely to grow strongly but they are headed higher. Moreover, the pace of earnings downgrades appears to have stabilised. The broker observes forecast earnings growth for the ASX200 index is low compared with history and offshore markets, but this is largely because miners and banks weigh on the aggregate. Earnings from industrial stocks look likely to achieve 10% per annum growth over the next two years. Deutsche Bank continues to favour housing and financial market exposure, adding some defensive names, yield plays and cost cutting stories as well.

The banks are not exciting, although the broker is mildly drawn to the fact that business credit growth looks to be returning. Deutsche Bank is overweight on the energy sector, as earnings surge on the back of LNG projects, but remains underweight in miners, as sliding iron ore prices pressure earnings. Other observations are that low price/earnings ratio (PE) stocks are expensive versus history and recent momentum has been poor. The broker is no longer underweight on high PE stocks. Another observation is that the yield premium from pure yield plays has shrunk. Deutsche Bank retains a preference for both yield and some growth potential.

***

The insurance industry is on the verge of major changes in technology. Morgan Stanley observes the multiplication of devices that are interconnected allows for new ways of selling and servicing product, whether it be motor, home, business or health insurance. Insurers are able to gain a better understanding of customers via new datasets, which means they assess risk in a completely different way. Risk pools are likely to shift and shrink, in the broker's opinion. An improvement in loss prevention is capable of delivering 40-60% risk reduction for home and 15-25% risk reduction for motor insurance. Moreover, consumer expectations have changed much faster than the industry, and insurers need to move ahead in terms of customer engagement, in the broker's view.

***

There was a common theme regarding expanding inventory in the FY14 results of electronic retailers and CIMB fears this brings increased downside risk. Retailers have geared up for a surge in demand in the first half of FY15 and, while underlying conditions are stronger, the broker suspects there is not enough risk priced in should sentiment soften into Christmas. For example, Harvey Norman ((HVN)) franchisees are holding inventory at around 22% of sales, up from 20% in recent years. Dick Smith ((DSH)) ended FY14 with closing inventory up 49% on the prior comparative period.

Dick Smith management suggested the stores were underweight in inventory as of June 2013 and had to build up in order to drive sales growth. Still, CIMB observes the company is holding significantly higher stock levels than its most comparable peer, JB Hi-Fi ((JBH)). While Dick Smith operates a distribution centre the broker does not believe this supports a higher relative inventory. The broker highlights an extreme example in the second half of 2012, when JB Hi-Fi's profit margin contracted substantially as Dick Smith, then owned by Woolworths, and Woolworth's Sight & Sound cleared excess inventory in an already-soft retail environment.

***

CIMB has reviewed its valuation consideration for Australian online media. Share prices and earnings multiples are at high levels and the broker's analysis indicates that valuation themes for Australian stocks are consistent with global comparatives. Yet expansion in multiples with no accompanied expansion in earnings does nothing to resolve valuation concerns, in CIMB's opinion. A case in point is REA Group ((REA)), which has grown its share price strongly over the past three months, driven entirely by price/earnings expansion as profit forecasts were revised slightly lower. Similarly, Seek ((SEK)) has enjoyed reasonable share price growth but the profit revisions were flat. Trade Me ((TME)) and Carsales.com ((CRZ)) are in the same mould, although the broker does envisages earnings upside at multiples which represent better value and a greater degree of safety with these two.
 

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article 3 months old

Australian Banks: Is It All Over?

By Greg Peel

For a couple of years up until last year, the story for Australia’s major banks has been one of replacing expensive offshore funding with domestic deposit funding and driving earnings in a low credit rate environment through the retirement of provisions taken at the height of the GFC against bad debts and general global risk. This combination has allowed the majors to increase their tier one capital ratios while at the same time handing out capital rewards to shareholders.

As is well documented, bank share prices have done nothing but rally over the period on the lure of dividend riches in a low yield world. For a long time the rally continued despite constant “overvalued” calls from bank analysts, until those bank analysts finally woke up to the fact the punters couldn’t care less about low non-provision earnings growth as long as the candy kept being handed out. The analysts then added a premium to their valuation models to account for the global demand for yield, and decided Australia’s banks weren’t so overvalued after all.

The story began to change however, as we headed into 2014. When three of the Big Four published their full-year earnings reports last November – Westpac ((WBC)), ANZ Bank ((ANZ)) and National Bank ((NAB)) -- analysts warned that the end to ongoing dividend increases and/or special dividends was likely nigh. On the one hand, GFC provisions were all but exhausted and would no longer provide earnings growth, leaving the banks once more at the whim of domestic credit growth. While credit growth had been quietly improving from very low GFC depths, it was still low by historical standards and would take a long time to fully recover in Australia’s imbalanced economy. The other issue was not one of profit and loss, but of balance sheets.

Australia’s big bank stocks have not just been favoured by domestic investors chasing yield but by offshore investors as well who, despite not enjoying the bonus gross-up of franking, have still been attracted to the Big Four’s AA credit ratings and world-leading capital adequacy ratios in the face of soon to be implemented global regulatory tightening. It had appeared that Australian bank capital ratios were already safely above new requirements, and at the same time the RBA was able to negotiate concessions on liquidity coverage ratios given Australia’s relatively small government bond market.

Then along came APRA. The prudential controller weighed into the argument and suggested that while Australian capital ratios might exceed those around the globe, Australia’s smaller domestic economy and reliance on offshore funding implied Australian banks should hold more tier one capital than their global peers. The global regulators introduced a category for banks called the domestic, systemically important bank, or D-SIB. Those familiar with the year 2008 would recognise D-SIBs as those banks deemed “too big to fail”. D-SIBs, it was decided, would be required to hold additional capital.

Australian banks, APRA suggested, should probably be required to hold further buffer on top of that additional capital.

By the time three of the Big Four had come around to releasing their interim profit reports last May, bank analysts had started talking less and less about earnings and more and more about capital. By the time Commonwealth Bank ((CBA)) reported its full-year result last month, earnings forecasts hardly scored a mention. Instead, all the attention was grabbed by the Financial System Inquiry (FSI) underway and talk was not just of additional capital buffers but of other regulatory restrictions to boot, all of which would weigh on bank share prices.

We recall that back in the GFC, the US government was forced to “bail out” America’s major banks and financial institutions by injecting equity capital using taxpayer funds. Europe pretty quickly followed suit, as did the UK, and indeed the eurozone reached the point at which the entire economies of the peripheral members were being bailed out by German taxpayers.

Greece was the poster child. It was bailed out and bailed out again. Then a sensation was caused when neighbouring Cyprus went down a different route. Cypriote banks weren’t bailed out, they were “bailed in”.

There were two major issues arising from the initial TARP rescue of US banks by the government. One was the simple “moral hazard” of using innocent taxpayer money to cover the backsides of greedy, and arguably fraudulent, bankers. The other was more technical. Had the US banks not been bailed out then they would have probably gone to the wall and all their creditors would have lost the lot. But they didn’t go to the wall, so the creditors argued they should be paid back in full. The government argued, from a moral standpoint, that it is only fair creditors should take “haircuts” on their loans (being paid back less than face value). The creditors argued, from a legal point of view, that you can’t change the rules mid-game.

The same tune played out across the globe until Cyprus, with eurozone support, introduced the statutory bail-in. This involved Cypriote banks being saved using forced haircuts for creditors and, most controversially, a proportion of excess funds held on deposit.  

In 2008 the Rudd government avoided having to use taxpayer money overtly to bail out Australian banks but it did implicitly use taxpayer money to provide a temporary deposit guarantee. Australia avoided the worst of the GFC fall-out, it can be said with the confidence of hindsight, but that doesn’t mean the same “moral hazard” arguments weren’t raised.

Returning to 2014, and last month’s second round of submissions to the aforementioned FSI, and we find not only are additional capital buffers still on the table for the Australian banking industry, but so are statutory bail-ins. And given the exorable link between bank risk and mortgage risk (which was what the GFC was all about after all), so too are mortgage risk weight considerations on the table.

Bank analysts are coming to the conclusion that whatever the FSI eventually decides when it hands down its recommendations in November, Australian banks are going to be required to hold more capital. And if the banks have to hold more capital, say goodbye to any further dividend increases.

APRA argues that Big Four’s capital levels are still inadequate on consideration of global relativities. The Big Four are arguing strenuously otherwise. They believe their tier one capital levels are above the global average on an “internationally harmonised” basis. They are also generally opposed to bail-ins, arguing they are unproven. It has also been pointed out the US taxpayer ultimately turned a profit on their 2008 bail-out funding for all bar General Motors (which means the investment banks, AIG, Fannie Mae and Freddie Mac).

The banks can argue till they’re blue in the face, but analysts largely agree FSI chairman David Murray is likely to push for more strenuous protection. Says UBS:

“We continue to believe that given Australia's unique situation as a small, commodity based economy, heavily reliant on foreign capital, with a very concentrated banking system, David Murray is likely to err on the side of caution. We believe this means both higher mortgage risk weights and D-SIB buffers despite the Majors' vehement objections.”

“Our view is that the main uncertainty is the extent of the higher capital and ‘bail-in’ that will eventually be imposed,” says CIMB.

“In our view,” says Morgan Stanley, “major banks will be required to hold more capital, despite the fact that they currently look well-positioned vs international peers. Our revised forecasts assume a 2% D-SIB buffer (vs 1% currently) and an increase in mortgage risk weightings (via a 20% risk weight floor).”

The bottom line is David Murray has not been given the task of deciding whether or not Australia’s banks can afford to pay out more dividends and thus attract share price support. His job is to ensure the safety of the Australian financial system into the future, lest another GFC situation were to arise. The last one scared the bejesus out of everyone.

Morgan Stanley goes on to sum up the mood:

“We sense that the Murray Inquiry wants to enhance financial stability and help restore competitive neutrality in the mortgage market. In addition, we think it needs to ensure that major Australian banks’ capital ratios stay at the top end of the global peer group, given Australia’s reliance on offshore wholesale funding. Accordingly, the trend towards higher capital levels around the world will lead to more onerous capital requirements in Australia.”

Morgan Stanley has moved to Underweight banks, suggesting the bank earnings upgrade cycle is coming to an end (as aforementioned here with regard GFC provision returns), and investors are underestimating the downside risk to bank returns on equity as a result of the Murray Inquiry.

But don’t panic! There are some caveats. Firstly, APRA is likely to allow a transition period, more than one broker suggests. Given the Big Four oligopoly, downside to earnings and returns on equity should be mitigated. Morgan Stanley, for one, is not assuming an Australian economic downturn as a base case and does not see a material housing correction ahead.

There is also another potential caveat with regard Australia’s unique position and, perhaps we might say, “smallness”. As was the case with regard global liquidity requirements vis a vis Australia’s small bond market, brokers suggest “bail in” rules may not be appropriate for Australia without some concession.

This might mean even higher tier one capital ratios to offset bail-in rules, UBS suggests, but the banks themselves argue higher ranking capital could replace additional tier one buffers, such as hybrid issues and senior debt that could be “bail-inable”. Credit Suisse is slightly at odds with other brokers in not assuming an additional tier one buffer is inevitable, suggesting APRA may yet accept the banks’ increased non-equity proposal.

Last month Citi pulled CBA back to a Neutral rating from Buy, such that the broker no longer has a Buy on any of the majors. This was not, however, a response to specific FSI risk with regard capital.

Citi believes the bull run of outperformance for Australian bank stocks over the past two years is likely to be coming to an end. Since the GFC, the majors have actively increased their returns on risk weighted assets to offset a decline in leverage (caused by having to hold more capital) in order to maintain their returns on equity. Subsequently, return on risk weighted assets is currently at a 25-year high.

But the glory days of the post-GFC era are over. Provisioning is returning to normal and pricing for risk is being re-established, Citi notes. Competition is re-emerging. The gradual reduction in the cost of bank funds since the GFC has run its course. Banks now face “significant” challenges in maintaining their returns on risk weighted assets, and hence Citi expects the average Big Four return on equity to decline to 12% from a current 16%.

As the cost of capital is presently around 10%, there is nothing to fear. But things are simply going back to “normal”, and in a “normal” economic environment, banks do not enjoy long-run share price outperformance as they return more and more capital to drooling shareholders.

The following table outlines current FNArena database broker forecasts for the Big Four based on yesterday’s closing prices:
 


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