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Australian Banks: It’s All About Politics

Feature Stories | Oct 20 2017

Conditions for Australia’s big banks are, if anything, improving, but brokers cannot become excited while political scrutiny continues to dominate.

This article was first published for subscribers on October 5 and is now open for general readership.

– Sentiment shot
– Banks in PR revival mode
– Earnings outlook not weak
– Political risk overhangs

By Greg Peel

When FNArena last updated on Australia’s banks in July (Australian Banks: Unquestionable Relief), APRA had just announced that the magic number was 10.5%. This tier one capital ratio for the big banks would satisfy the regulator that bank balance sheets were “unquestionably strong”.

There was much relief, given (a) 10.5% was not as large a number as feared and (b), the Big Four were already well on the way to reaching that figure and still have until 2020 to get there. But that relief was bitter sweet, given the federal government had just slapped a levy on all of the Big Four and Macquarie ((MQG)).

This was the Coalition’s way of appeasing the howling mob, which had been gathering outside local branches with pitchforks raised following a series of bank indiscretions, one of the most recent having been the CommInsure scandal. Labor was continuing to call for a Royal Commission and that is a very popular idea among said mob.

Also in focus in July was the banks’ ability to reprice their mortgage books, specifically for investor and interest-only loans, thanks to APRA’s regulatory crackdown. Politicians could not cry foul this time around. Such repricing was providing the banks with an opportunity to grow earnings in an otherwise benign credit growth environment.

The consensus among bank analysts was that the outlook for bank share prices was fair to middling. As ever, prices are ultimately supported by fully franked dividend yields but as to upside, there was nothing to be particularly excited about.

Then along came AUSTRAC.

A very simple analysis shows that if we add up the Big Four bank share prices (without cap weighting), a sum of $178.10 in July has now fallen to $167.70. Consensus broker target prices have fallen only from $176.79 to $173.39. Analyst valuations have not manifestly diminished, only investor sentiment has. And the bulk of that share price reduction can be put down to a drop for Commonwealth Bank ((CBA)) to $75.37 from $84.81.

We are yet to learn of the outcome of the supposed thousands of lawsuits CBA could be hit with as a result of their ignorant complicity in money laundering for criminals and terrorists, and whether suggestions of the billions it could cost the bank are in anyway realistic. Presumably they are not. We are also yet to hear any more on the matter of to what extent the other banks are also involved. But suffice to say, CBA has not done the banking sector any favours.

ATM Fees

CBA’s CEO has since fallen on his sword. Fearing further political recriminations, and perhaps that long called for Royal Commission, the bank has begun to try to win back public favour.

Last month CBA announced it would no longer charge “foreign” ATM fees, meaning the two dollars one pays to use an ATM not owned by one’s own bank. Within a heartbeat, the other three banks followed suit.

Foreign ATM fees are just another in a long line of fee cuts the banks have been undertaking over recent months, either voluntarily or under regulatory requirement. While not exactly exorbitant, they are nevertheless another little gripe held by bank customers. Thus for CBA and Co, cutting ATM fees is a public relations exercise. The bottom line is those fees are chump change for the banks.

Bank analysts estimate each bank was collecting around $40-50m annually from foreign ATM fees. Deutsche Bank, for one, suggests this translates into around a -0.2-0.3% earnings reduction. Macquarie concurs. And the reality is, that number is $40-50m and falling. ATMs are soon to become museum pieces.

Over the past few years, Australians’ use of ATMs has been declining in step with the growth of cashless payment alternatives such as Pay Wave and smart phone apps. While once the extent of a bank’s ATM network was seen as a selling point to customers, more recently it has been assumed the banks would start pulling them out. Walk down any suburban or regional high street and you’ll find a branch of all four big banks, and maybe a couple of smaller ones as well, all within spitting distance of each other. And they all have ATMs.

Increasingly unnecessary in an ever more cashless world. But the fact the banks would choose now to suddenly decide to cut those foreign fees is testament to the current climate under which they are living – one of ever increasing public and political scrutiny.

Back to Banking

Shortly after the fee cut announcement, CBA announced it had sold its A&NZ life insurance business to AIA Group, and touted that it is looking to also sell off its Colonial First State wealth management business, maybe through an IPO.

The news did not come as surprise. Bank analysts have long predicted such a hiving off of the big banks’ wealth and insurance businesses as a means to consolidate and focus on what they do best – banking – and to thus shore up capital positions in the face of increasing regulatory requirements and limited prospects for earnings growth. Such businesses are capital and cost intensive. Last year National Bank ((NAB)) sold off 80% of its own life insurance business.

And at the end of the day, such sales do not impact broker valuations. The prices realised in both the NAB and CBA sales were consistent with earnings streams lost, hence neutral to value.

But behind the simple maths is another burning reality. Prior to the AUSTRAC scandal, previous bank scandals, of which there have been many, mostly centred around insurance and wealth management. As Deutsche bank puts it, CBA’s sale of its insurance business “facilitates the group’s exit from a capital intensive business which has reputational risk, and which is increasingly regarded as non-core”.

With its reputation in tatters, CBA has been forced to do more than just cut two dollar ATM fees. Clearly senior management in all banks have found it increasingly difficult to sufficiently keep tabs on unwieldy conglomerates of extensive financial services. Exit those businesses and the chance of even more scandals erupting goes with them.

Reputational Risk

Goldman Sachs noted, in writing at the time, that in the 35 days since AUSTRAC initiated civil proceedings against CBA the bank’s share price fell -10%, underperforming the bank index by -5.6%. Goldman has delved into how this compares with past “banking incidents” globally.

In all cases, banks underperform peers in the 12 months after the incident by an average of -20%. In only one case, which involved UBS, did a stock outperform between 35 days and 12 months. Only one incident (Standard Life) resulted in a PE de-rating in the first 35 days greater than that of CBA’s. On only one occasion (NAB) did relative PE re-rate among peers between 35 days and 12 months.

Typically, notes Goldman, underperformance in the first 3-4 months is driven by PE de-rating, meaning sentiment. Thereafter, further de-rating comes down to earnings forecast downgrades. To date, forecast changes for CBA have been among “the best”, meaning smaller, at 35 days. However this did not stop Goldman Sachs cutting its price target for CBA given AUSTRAC risk and the lessons of history.

The Actual Outlook

Take out reputation risk and the risk of greater regulatory/political scrutiny, and things aren’t looking so bad for Australia’s banks.

There remains an opportunity for further mortgage repricing. Bad loan risk continues to remain benign. Wholesale funding costs have been coming down. Term deposit spreads have been going up. Yesterday the RBA noted: “Over recent months there have been more consistent signs that non-mining business investment is picking up”.

Of course, there remains the small matter of housing market risk, but consensus expectations on that front are leaning towards “cooling” rather than any form of crash. At the same time the RBA is lauding a long awaited pick-up in business investment, it continues to warn of elevated household debt vis-à-vis low wage growth. If interest rates rise, will stretched households be able to keep up with the mortgage payments?

On that note we also recall earlier last month when UBS lifted the lid on “liar loans”. Citing a survey which found only 67% of mortgage applicants could insist their applications were “completely factual and accurate”. UBS also found that 46% of respondents suggested that despite regulatory crackdowns, it is actually easier now to get a mortgage than it was previously.

The broker, hence, estimates that there are $500bn of factually inaccurate loans on banks’ books, implying mortgage holders are more stretched than already feared and losses in a downturn could be larger than banks anticipate.

Analysis by Shaw & Partners finds that in recent times there has been a strong correlation between bond yields and bank share price performance. As interest rates rise, so too do bank valuations. However in the last couple of months, that correlation has broken down.

Which brings us back to sentiment. Global bond yields are rising or at least threatening to rise and in Australia there has been much debate about what the timing of the next RBA policy shift might be. No one is arguing the direction. In theory, thus, bank valuations should be rising, but instead they have fallen.

This leads Shaw to conclude “value is pretty good for the banks”. UBS concluded its “liar loan” report by saying “We are underweight Australian banks and are very cautious over the medium term outlook."

As an aside, Morgan Stanley warns that were the Labour Party to ultimately win government in New Zealand, its intention to address negative gearing, capital gains tax and foreign investment and to slow immigration will impact on the NZ housing market, to which ANZ Bank ((ANZ)) is some 20% exposed and the other three some 10%.

It would be an interesting case study, the broker suggests, given the Australian Labor Party has a lot of similar ideas.


Put all of the above together and we find a general view among bank analysts that, while the outlook for the sector is a little brighter in the short term, risks remain, and the most predominant of those risks relate not to banking conditions, but to regulatory and political scrutiny. With yield offering the safety net, most analysts are adopting a neutral stance.

In terms of individual banks, the current state of play among the eight brokers in the FNArena database looks like this:

For as long as anyone can remember, CBA has traded at a premium to its three peers given its size and reputation and throughout that period, bank analysts have continued to call that premium unwarranted. Now they don’t have to, because that premium has gone.

But despite this historical event, analysts have not responded by suggesting CBA is any better value now than it was. Have a look at the same table from back in July:

Only one share price has changed notably in the period, and only one target price is showing much difference – CBA. There has been very little change in individual ratings, other than NAB to slip ahead of ANZ in the middle while Westpac ((WBC)) remains as most preferred and CBA as least.

It’s all about caution, and that’s all about AUSTRAC, the regulators, and political frustration.

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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