Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 279

Bank reporting season scorecard for FY18

On Monday this week, Westpac ruled off the 2018 financial year profit results for the Australian banks. In the words of Queen Elizabeth, 2018 could only be described as an annus horribilis for Australian banks and their investors. The CEO of one major bank lost his job, the revelations of the Financial Services Royal Commission resulted in remediation provisions and a spike in legal fees (which should see new sports cars and houses at Palm Beach for sections of the legal community this Christmas), fines were levied and credit growth slowed. An environment of fear has weighed on bank share prices.

There are common themes emerging from the banks in the 2018 reporting season. We will differentiate between the major trading banks and hand out our reporting season awards to the financial intermediaries that grease the wheels of Australian capitalism.

Click to enlarge

Scaling back the empire

The main theme from 2018 was the breaking down of the allfinanz model that the banks built up carefully over the past 30 years. Allfinanz or bancassurance refers to the business model where one financial organisation combines banking, insurance and financial services such as financial planning to provide a financial supermarket for their customers. This is based on the somewhat false assumption that the bank's employees can efficiently cross-sell different financial products to their existing customers at a lower cost than if this was done by separate financial institutions. It creates some of the conflicts of interest that have been on display at the Royal Commission.

Over the past year, the Commonwealth Bank sold its life insurance business to AIA and the asset management business a week ago to Mitsubishi UFJ for a very solid price. Similarly, ANZ exited both its wealth management and life insurance businesses. NAB also announced plans to sell MLC by 2019. Additionally, Westpac has reduced its stake in BT Investment Management (now renamed as the Pendal Group). These moves acknowledge that creating vertically-integrated financial supermarkets was a mistake. If adverse rulings are made on vertical integration in the Royal Commission’s Final Report, most of the banks will have already made moves to simplify their businesses, so shareholders won’t be exposed to significant 'fire sales' of assets by motivated sellers.

Profit growth hit by remediation

Across the sector, profit growth was subdued in 2018 as the banks grappled with slowing credit growth, the application of tighter lending standards, customer remediation and legal costs. The table above looks at the growth in cash earnings inclusive of these costs. Whilst many companies encourage investors to look through these charges, ultimately these are real costs that impact the profits available to shareholders, and in aggregate the four banks have set aside $1.3 billion to cover customer remediation.

Westpac reported the strongest cash earnings by cost control, very low bad debts and a lower level of customer remediation charges. NAB brought up the rear due to both $755 million in restructuring costs and $435 million in customer remediation charges.

Bad debts stay low

A big feature of the 2018 results for the banks has been the ongoing decline in bad debts. Falling bad debts boost bank profitability, as loans are priced assuming that a certain percentage of borrowers will be unable to repay. Additionally, declining bad debt charges year on year creates the impression of profit growth even in a situation where a bank writes the same amount of loans at the same margin. Bad debts fell further in 2018, as some previously stressed or non-performing loans were paid off or returned to making interest payments. The main factors causing this fall has been the low unemployment rate and a near absence of major corporate collapses over the past 12 months.

Westpac and Commonwealth Bank both get the gold stars with very small impairment charges courtesy of their higher weight to housing loans in their loan book. Historically home loans have attracted the lowest level of defaults.

Shareholder returns hold as dividends steady

Across the sector, dividend growth has essentially stopped, with Commonwealth Bank providing the only increase, two cents, over 2017. In an environment where loan growth is slowing, provisions rising and the management teams regularly appearing either in front of the Royal Commission or before our political masters in Canberra, it would be imprudent for the banks to raise dividends.

In 2018, dividends were maintained across the banks, which was a surprise in the case of NAB. It paid $1.98 in dividends on diluted cash earnings per share of only $2.02, a very high payout ratio and not a sustainable situation given that the bank’s capital ratio is below the APRA target of 10.5%.

Looking ahead, dividend growth is likely to be subdued in 2019, as the banks digest the outcome from the Royal Commission. ANZ and Commonwealth Bank shareholders can expect capital returns in the form of share buy-backs to offset the dilution from asset sales. In 2018, ANZ bought back $1.9 billion of its own stock, with an additional $1.1 billion due over the next six months. The major Australian banks in aggregate are currently sitting on a grossed-up yield (including franking credits) of 9.4%, an attractive alternative to term deposits.

Interest margins

The banks’ net interest margins [(Interest Received - Interest Paid) divided by Average Invested Assets] in aggregate declined in 2018, reflecting higher wholesale funding costs and borrowers switching from interest only (which attracts a higher rate) to principal and interest mortgages. This switching was done in response to regulator concerns about an overheated residential property market, and in particular the growth in interest-only loans to property investors. Looking ahead to 2019, margins should recover courtesy of a rate rise of around 0.15% announced in mid-September. All the banks put through a similar rate rise with the exception of NAB, and it will be interesting to see whether NAB increases its market share as a result of this or follows suit at a later date.

Total returns including share prices

All the banks have delivered negative absolute returns, also trailing the S&P/ASX200 which eked out a small gain of 0.24%. The uncertainty around the outcomes from the Royal Commission, rising compliance costs and slowing credit growth has weighed on their share prices. Westpac has been the worst-performing bank, mainly due to concerns about lending standards in the $400 billion mortgage book, though we are yet to see any adverse evidence in the form of rising bad debts.

– No star given –

Our overall view of the future

It is hard to be a bank investor at the moment and some fund managers are advocating avoiding them all together.

We view that at current prices, investors are being paid an attractive dividend yield to own solid businesses that have a long history of finding ways to grow earnings and navigate political minefields. Looking at the wider Australian market, the banks look relatively cheap, are well capitalised and unlike other income stocks such as Telstra, should have little difficulty maintaining their high fully-franked dividends. Additionally, the share prices of ANZ and Commonwealth Bank will see the benefit of share buy-backs, as the proceeds from the sales of non-core assets are received. The key bank overweight positions in the Maxim Atlas Core Equity Portfolio are Westpac, ANZ and Macquarie Bank.

 

Hugh Dive is Chief Investment Officer of Atlas Funds Management. This article is for general information only and does not consider the circumstances of any investor.

 

RELATED ARTICLES

Bank reporting season scorecard for FY19

Bank reporting season scorecard: May 2018

Bank reporting season scorecard May 2021

banner

Most viewed in recent weeks

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Noel's share winners and loser plus budget reality check

Among the share success stories is a poor personal experience as Telstra's service needs improving. Plus why the new budget announcements on downsizing and buying a home don't deserve the super hype.

Grantham interview on the coming day of reckoning

Jeremy Grantham has seen it all before, with bubbles every 15 years or so. The higher you go, the longer and greater the fall. You can have a high-priced asset or a high-yielding asset, but not both at the same time.

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Buffett says stock picking is too hard for most investors

Warren Buffett explained why he believes most investors should not pick stocks but simply own an S&P 500 index fund. "There's a lot more to picking stocks than figuring out what’s going to be a wonderful industry."

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Latest Updates

Exchange traded products

ETFs are the Marvel of listed galaxies, even with star WAR

Until 2018, LICs and LITs dominated ETFs, much like the Star Wars franchise was the most lucrative in the world until Marvel came along. Now ETFs are double their rivals, just as Marvel conquered Star Wars.

Shares

Four leading tech stocks now look cheap

There are few opportunities to buy tech heavyweights at attractive prices. In Morningstar’s view, four global leaders are trading at decent discounts to their fair values, indicating potential for upside.

Shares

Why copper prices are at all-time highs

Known as Dr Copper for the uncanny way its price anticipates future economic activity, copper has hit all-time highs. What are the forces at play and strategies to benefit from the electric metal’s strength?

Economy

Baby bust: will infertility shape Australia's future?

In 1961, Australian women had 3.5 children on average but by 2018, this figure stood at just 1.7. Falling fertility creates a shift in demographics and the ratio of retirees to working-age people.

SMSF strategies

The Ultimate SMSF EOFY Checklist 2021

The end of FY2021 means rules and regulations to check for members of public super funds and SMSFs. Take advantage of opportunities but also avoid a knock on the door. Here are 25 items to check.

Economy

How long will the bad inflation news last?

The answer to whether the US inflation increase will prove temporary or permanent depends on the rates of growth of the quantity of money. It needs to be brought down to about 0.3% a month, and that's a problem.

Economy

The ‘cosmic’ forces leading the US to Modern Monetary Theory

If the world’s largest economy adopted a true MMT framework, the investment implications would be enormous. Economic growth would be materially greater but inflation and interest rates would also be much higher.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.