Australia | Sep 15 2020
The current state of the economy suggests a recovery for Australia's banks is likely to be a drawn-out affair, featuring margin headwinds, weak credit growth and elevated costs.
-Bank valuation still “reasonable” compared with historical downturns
-Large increases in household savings, expenditure below long-run averages
-Risk to the downside until more clarity on credit quality, dividends, capital
By Eva Brocklehurst
While the current state of the economy appears manageable for Australia's banks, a recovery is likely to be drawn out. Asset quality is dominating discussions and margins are under pressure amid subdued credit growth and elevated costs.
Yet JPMorgan finds asset quality trends actually hard to ascertain, given the subjectivity of bank provisioning and vastly different reporting of arrears, credit risk and loan loss charges. Still, in an international context, Australia's major banks appear relatively attractive, CLSA asserts, given their income perspective compared to the rest of the market and bond yields.
Regional banks continue to be challenged, nevertheless, and the broker points out both Bendigo & Adelaide Bank ((BEN)) and Bank of Queensland ((BOQ)) are trading close to long-term averages. Valuations appear reasonable among the major banks when compared with historical downturns and CLSA prefers National Australia Bank ((NAB)) and ANZ Bank ((ANZ)) over Westpac ((WBC)) and Commonwealth Bank ((CBA)).
While NAB's provision coverage is at the low end of peers, its capital position is strong. Meanwhile, ANZ offers greater leverage to an improving economy as and when asset quality concerns subside. Bank stocks appear too cheap to short, JP Morgan asserts, as most are trading below book value, and greater macro certainty is required in order for stocks to re-rate meaningfully higher.
Recent guidance from APRA (Australian Prudential Regulatory Authority) provides some clarity on what investors can expect in terms of dividends. Still, a re-emergence of dividends, while helpful, is not enough in JP Morgan's view.
Morgan Stanley believes ANZ will show the strongest recovery in dividends over the next two years, although assumes major bank dividends in FY22 will still be at an average of -25% below pre-pandemic levels.
On the other side of the ledger, CLSA, while acknowledging it deserves a premium, believes CBA is too stretched and there is more leverage from an improving economy in the other banks. The broker assesses Westpac continues to face underlying earnings pressure and there is uncertainty surrounding the matters raised by the Australian financial intelligence agency, AUSTRAC.
Morgan Stanley agrees Westpac appears to have the smallest margin for error on capital but notes a preference to sell assets in its specialist division. CEO Peter King has indicated there is plenty of interest in these assets although a sale process is likely to take time.
Citi agrees that asset sales hold the key for Westpac, analysising a potential sale of Westpac's BT business. Westpac is the laggard in offloading of wealth management, a process undertaken by the major banks over recent years.
The complete exit by other major banks has represented sound strategy and execution but the broker believes the implications for Westpac are mixed. BT remains the “jewel in the crown” of those assets that are still in bank hands.
BT is number two in Australia terms of funds under administration. Moreover, there are options available to improve, such as shutting down and migrating Asgard, along with synergies from combining with any platform that is below it in terms of industry structure.
There is also the issue of whether Westpac could sell the whole business. It is not straightforward for a buyer to find what Citi calculates could be a $3bn price tag. Hence, the strategic value of BT is growing in terms of its scarcity value.
Westpac remains the broker's top pick in the sector, given the quality of its book, potential long-term returns and the feasible asset sales that can unlock capital.
The state of the economy will be the biggest driver of the outlook for loans. CLSA notes the banks all have slightly different definitions of deferral arrangements. Still, the majority have experienced a greater proportion of home loan deferrals from Victoria and, unsurprisingly, fewer in Queensland.
Major bank deferred loans range across 7-12% of balances for home loans and 14-16% of balances for business loans. The most affected sectors for the latter are those in consumer and property-related industries.
The next date of significance comes at the end of September when the initial six-month deferral period ends. The banks will then find out whether deferred customers are able to move to some form of repayment.
Morgan Stanley notes ANZ and CBA are winning share in mortgages while growth rates at NAB and Westpac have bounced around. Bendigo & Adelaide and Macquarie Group ((MQG)) continue to win share in the mortgage market, growing at double-digit annualised rates.
Meanwhile, there has been a large increase in savings, with household deposits up 3% in July, month on month. Expenditure intentions remain well below the long-run average and the national savings rate was up to 20% in the June quarter, from 6% in the March quarter. This also likely reflects a significant one-time boost to cash flow from superannuation withdrawals.
Morgan Stanley highlights deposit growth is less beneficial for the banks when interest rates are low and loan growth is subdued. The recent reporting season suggests there will be further headwinds in this regard and higher liquidity has reduced margins by more than -5 basis points in the June quarter. Meanwhile, the decline in lending to corporates continues.
However, JPMorgan notes spreads on savings products and term deposits have improved over the last three months and this should provide a meaningful tailwind for major bank interest margins. It remains to be seen whether management commentaries, which pointed to pressures from competition and low rates during the August reporting period, are overly conservative.
The broker's top pick remains NAB, although its position on small-medium enterprises (SMEs) feels like "right place at the wrong time". In the longer term, JPMorgan believes the bank's status as a lender to SMEs will be the positive differentiator that will allow revenue to outperform peers.
CLSA expects FY21 CET1 ratios to be weaker across the sector, with the exception of CBA, because of the benefits from divestments. This in turn reflects expectations that bad debts will remain elevated.