This week Guy Carson takes a look at the Big Banks in light of their recently released results. This is an essential read in the wake of the Royal Commission.
Whilst the Royal Commission rolls on in the background, it came as some relief to bank shareholders that the focus over the last few weeks switched to the interim reporting season. As a whole, the results of ANZ, NAB and Westpac were well and truly mixed. To summarise in very brief terms, I would say that Westpac produced a good result, NAB was weak and ANZ was somewhere in between. With the lack of a smoking gun within the financial statements, it appears valuation support has arrived for the shares of the Big 4. Investors appear happy to accept roughly a Price to Earnings ratio of 12x and a dividend of 6%.
In Australia, we tend to be a little insular and the value of the banks is typically measured against the ranges that they have traded within recent history. On those grounds they are cheap and remain significantly below multiples seen at their peaks in 2015. However, if we take a broader view, the major Australian banks still trade at premiums to global peers in terms of both Price to Earnings multiples (P/E), and Price to Book (P/B) whilst maintaining significantly higher payout ratios. The below table uses consensus data to compare the major and regional banks against some of the largest banks in the US and Europe. From this data, we can see that the Big four are slightly more expensive than US banks and significantly more expensive than those in Europe. CBA stands out (despite its recent price falls) as very expensive.
Despite the stocks having found some support at recent levels, we are always cautious on relying on a single data point such as a one year P/E multiple to rate how cheap and expensive a stock is can be dangerous. This is because the E in a P/E multiple can move and lead both to change in the multiple as well. In order to gain a further understanding of how the E might move it is important to understand the current trends underlying their businesses.
When we had a look beneath the surface of the recent results, a few things stood out to us. Firstly, headline growth is soft and the results have been reliant on new cycle lows in provisioning (this is most notably the case for ANZ). Secondly, funding costs have risen recently and this will put pressure on Net Interest Margins going forward (if not for the royal commission we believe the major banks would be looking to hike mortgage rates). Finally, Western Australia remains a huge concern for the banks.
Firstly, growth has clearly slowed.
Westpac’s growth outpaced the other two due to higher asset growth plus an increase in their Net Interest Margins (NIM). For ANZ and NAB, NIMs were broadly flat whilst for Westpac they rose. Westpac has the largest interest only mortgage book amongst the banks and the repricing last year would have a beneficial impact. Amazingly though, Westpac saw their NIM increase across all divisions.
One of the key positive drivers of the results was falling provisioning.
As can be seen below, the levels of provisioning have fallen to new cycle lows (ANZ on the left, NAB on the right). As mentioned above the shares appear to have found a little bit of valuation support based on the current multiples of earnings. A small increase in provisioning in future periods could be the trigger that leads to a fall in Earnings and a derating for the share price. When (and not if) this happens and the severity of the increase are the unknowns at this stage.
The big question for the banks from here is how do they grow? It is likely that credit growth will continue to be difficult. Over the last year, total loans at both ANZ and NAB grew by just 3% over the last year whilst Westpac grew at a more aggressive 5%. An increased focus on credit quality and loan serviceability is one of likely outcomes from the Royal Commission (and in fact we are starting to hear evidence of it). This means the days of high credit growth are behind us. In addition, the banks continue to exit wealth management having failed dismally at. Growth drivers are few and far between and hence the aggressive shift to cost cutting, most notably from ANZ and NAB.
Moving on to funding costs and they have started to rise. The full impact of this will be seen in the bank results in six months’ time. From NAB below, we can see the recent spike in spreads. The impact, if current funding costs were maintained across the entire 6 month period, is a reduction in NIM of 2-3bp. The banks would probably like to pass this on to the customers but with the royal commission currently running, the banks will be cautious about doing anything to attract further negative press. Interestingly some second tier lenders that aren’t currently under public scrutiny have moved up mortgage rates recently.
And finally moving onto arrears and the movements there. Arrears in Western Australia continue to rise at a rate of knots (ANZ on the left, NAB on the right). ANZ noted that losses in the region are also rising. CBA has the highest exposure to WA at 17% of its residential book; its result in August will be interesting.
It’s also worth noting that arrears in all states and the portfolio as a whole are trending up. At this stage though provisioning is not budging. The below chart from the RBA shows the relationship through time and suggests if arrears continue to rise then increased provisioning will follow. With a slowing housing market and tighter credit, we see this is a significant risk over the next few years.
At this stage the losses have been kept in check for the banks. It appears LMI lender Genworth Mortgage Insurance Australia is copping the brunt of it. Genworth’s recent first quarter result saw profit down 83.9% as their loss ratio came in above expectations.
The share prices of the banks have breathed a sigh of relief with valuations coming back into focus. However, as highlighted above the latest results are relying to some degree on falling impairments in order for profit growth. In our opinion this is unsustainable over the medium to long term. Credit growth is likely to remain weak and could potentially turn negative with tighter lending standards arising from the royal commission. If profit growth stalls, dividends will come under threat. Whilst current multiples appear undemanding, the risk still appears to us to be firmly to the downside.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.