By Greg Peel
FNArena last provided an update on the state of play of Australia's Big Bank sector on October 22, the day after National Bank ((NAB)) announced a surprise pre-result profit warning (See NAB Fires The Warning Shot). The announcement provided analysts with the opportunity to assess any read-through of NAB's warning – which was all about provision top-ups – to the sector as a whole.
As at October 22 we found ANZ Bank ((ANZ)) well ahead in the preference stakes with a Buy/Hold/Sell ratio from the FNArena broker database of 5/2/1, with the unusual situation of the other three all placing “second” with 1/5/2 ratios. ANZ was the stand-out based both on valuation and outlook. The share price had only just reached the consensus target price and ANZ's Asian interests provide the smaller bank with a point of difference. By contrast, NAB's UK exposure and potential for further bad debt provision top-ups left analysts wary, while the bigger Commonwealth ((CBA)) and Westpac ((WBC)) had both well exceeded their consensus target prices, leading to valuation calls.
Our October 22 table looked like this:
Taking today's traded prices as at 2pm (given a bit of a sell-off this morning), our fresh table looks like this:
The first thing we notice is that the rating ratios have not changed despite all of NAB, ANZ and Westpac having now posted official full-year earnings reports, and CBA having provided a quarterly update. The lack of change actually masks some broker disagreement – Westpac's result prompted an upgrade to Buy from Hold from Citi and an offsetting downgrade to Hold from Buy from Credit Suisse. The analysts actually agreed that Westpac's result was the most impressive of the four, but Credit Suisse has a target of $26.75 and Citi of $28.50, providing different valuation calls.
Looking at share prices from October 22 to today we find NAB down 11.1%, ANZ down 5.5% and Westpac down 2.4% with CBA bucking the trend with a 3.7% gain. You've got to hand it to CBA – for years now the majority of brokers have considered its premium to the other three to be unjustified, but more on that a bit later.
Interesting are the changes in the “Upside to Target” measure. As FNArena has suggested time and time again and was reiterated in the October article, when bank share prices exceed consensus target prices they are likely topping out for the time being. Since the profit results came in, ANZ has moved from being on its target to 8% below it, NAB has moved from being 1% over to 11% under, and Westpac has fallen from 8% over to 2% under. CBA is clearly the stand-out here too, having risen from 4.5% over to 6.5% over.
Once again the FNArena Bank Rule has worked (except for CBA). Ah hah! I hear you think, but the post US election sell-off can explain that! Quite true, but FNArena never offers a reason as to why the top-outs might occur. Exogenous reasons are perfectly acceptable.
So we can see the new state of play in terms of the stats, but what did the results season tell us about how the Big Four are actually performing?
There were no major surprises. Arguably the initial NAB profit warning should be called a surprise given subsequent earnings and rating downgrades from the analysts but realistically analysts had been worried for some time that NAB's provisions were behind the curve. NAB suffered even further earnings forecast trims on its official release given a lack of quality in the profit the bank did declare – there was a big contribution from the volatile proprietary trading division.
Beyond that, results largely reflected analyst expectations based on the current economic environment. Earnings growth remains modest at best. Credit Suisse notes a deceleration in “average earning asset growth” in the second half of the fiscal year (May-September) which basically means the banks are writing less loans. This is particularly the case outside housing. At the same time, the banks continue to grind along, Citi notes, increasing their capital and liquidity positions to ensure compliance once the new and complicated global regulations are eventually enforced.
In order to achieve such compliance, the banks need to keep collecting domestic deposits on their balance sheets. Offshore funding costs have came down over the year which should imply the capacity for the banks to lower their deposit rates, but this is not yet the case and competition remains fierce. This is putting a lot pressure on the banks' basic profit mechanism – net interest margins. The offset here has been aggressive cost controls, which have allowed the banks to maintain reasonable overall profit margins.
The outlook for “asset growth” is not good. Yesterday we saw some positive September data in the housing finance sector with investment loan growth impressive as the RBA easing cycle continues. However this morning's release of the NAB business survey for October was nothing less than a Barry Crocker. Australian business conditions have not been as weak since mid-2009 and with confidence also low there is little sign of improvement for business sector credit growth. Even mining is on the wane. (See Oz Business Conditions Worst In Three Years)
The end result is that on a stand-alone basis, investors would have to think there are far better opportunities among the listed Industrials than the banks with their poor earnings outlooks. If we look at FNArena consensus earnings growth forecasts for FY13, ANZ is offering 3.2%, NAB 3.9%, CBA minus 0.8% and Westpac minus 1.9%. Overlaying those forecasts is a fear that collective provisions may again be falling below sufficient levels.
This is especially true for those banks exposed to the mining states of Western Australia and Queensland, which see NAB and Westpac in the frame. The sluggish economy of the south-eastern states has been understood for some time but mining has been driving businesses in WA and Queensland, as well as consumer spending and house prices. A turn-down in these states could well lead to increased bad and doubtful debts. For all banks, nevertheless, ongoing weakness in manufacturing, services and construction (as indicated by very weak PMIs) is a concern.
Housing might be a bright note, if there really is a turn underway, but the Big Four are loaded to the gunwhales with mortgages and do not necessarily want too many more. This is evident in the opportunity taken up by the banks not to lower their mortgage rates by as much as the RBA lowers its cash rate.
If we add it all up – low to negative earnings growth forecasts, requirement for more capital, the danger of increasing bad debts – the next question is as to whether the banks can continue to pay the level of dividends being paid at present. For it is yield, at present, which pretty much negates all the above problems which might otherwise keep investors away from banks.
Why is CBA a perennial over-achiever? Because it's big, it's safe, it has a good credit rating and is offering a yield that is not only well in excess of the government bond yield (even before taking franking into account) but is hugely in excess of yields available to offshore investors. As long as yield is sought, so will CBA be sought.
The same is true for the others as well but CBA just has that reputation. All banks have quietly restored their dividend payout ratios after having to cut them immediately after the GFC, and it these ratios which provide value for investors. If the banks do earn less, they pay less in absolute terms. But they would have to pay a lot less before the yields on offer become globally unattractive.
The Big Banks will continue to move in “beta” terms along with movements in the index based on global influences. On a sector basis they are underpinned by yield, offering “outperformance” in weakness. The banks have once again become “defensive” in this sense.
The cloud, however, is an Australian economy now looking at below trend growth, and hence there is a potential for bad debt provision top-ups from the banks out of the pool from which those dividend payouts are drawn.
Technical limitations
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