Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 257

The outlook for Australian banks

A good way to judge how companies are performing in Australia is to compare stockbroker price targets before and after the release of financial results. It's a straightforward measure and cuts out noise about one-offs and taxes, currency fluctuations, management ability and strategy execution.

Notable movements in share price targets

After cloud accountancy software provider Xero released its FY18 financial report in May 2018, price targets went up. When property listings platform REA Group provided an update on the March 2018 quarter, price targets went up. The same happened for News Corp, though that was largely REA-inspired. After Macquarie Group released their financial report last month, price targets jumped.

And the banks? Every one has recently seen price targets decline on the back of financial results, or, in the case of CBA, a quarterly trading update. Most commentators point at ‘cheap’ valuations for the banks (except Bendigo and Adelaide) given most are trading below consensus (and declining) price targets.

Banks are finding it difficult to participate in the broad-based market recovery, regardless of all the value calls, the fact that cheap-looking laggards have been regaining investor interest, and despite most banks paying above-market half-yearly dividends.

The IBISWorld view on banks

Clearly, something else is going on and it's not just about ongoing despicable embarrassments at the Royal Commission. Sector analysts at IBISWorld are widely known for their specialised sector research reports such as on retail spending and new trends in consumer electronics. They have weighed in on what lies ahead for the sector once thought of as the closest thing to ‘indestructible’ by Australian investors (but no longer).

On their assessment, Australian banks will be hamstrung with higher capital requirements, tighter regulation, and higher costs as a result of the public outrage over their misconduct in years past, and the regulatory and political scrutiny that follows as a result. While IBISWorld suggests higher costs will be partially passed on to clients, the analysts now forecast declining revenues for the next five years.

Another consequence of the Royal Commission should be tightened standards for lending to investors, consumers, and businesses, suggest the analysts. While this opens up a drive for increased market share by smaller competitors, including non-bank lenders, this will also have consequences for credit growth in general, which closely intertwines with economic momentum and house prices in Australia.

The UBS analysis of the sector

UBS's negative view on banks has consequences for the broader domestic economy with the house view fearful that tighter credit is likely to lead to weaker house prices. There will be a flow-on impact on household sentiment through a fading of the so-called wealth effect that stems from positive momentum for property prices.

No surprise then, that UBS thinks GDP growth forecasts by economists elsewhere are likely to prove too optimistic, including the 3% forecast maintained by the RBA for 2018. UBS suggests 2.75% is more likely, and this will keep interest rates on hold until the second half of 2019.

In a separate analysis, UBS economists suggest that tighter public scrutiny in Australia has the potential to spread to New Zealand. This could translate into yet more pressure for Australian banks who also dominate across the Tasman.

While further tightening of credit in New Zealand would add more downside risks for house prices and consumer spending there, and potential for bad debts to rise, an equally-intriguing observation can be made from the graph below, taken from that same UBS report on Australian banks in New Zealand.

The graph shows the tightening by banks had an almost immediate impact on house prices where there was elevated momentum (Auckland), and that a softening in lending standards once house prices were falling takes a lot longer to then stabilise the market.

The JP Morgan perspective on banks

JP Morgan recently wrote that Australian banks had let their standards slip, as was also revealed at the Royal Commission. APRA had already instructed banks to set limits on new loans in high debt- and high loans-to-income categories, in industry parlance known as DTI and LTI loans. With aggregate household debt in Australia rising to 189% of disposable income, JP Morgan believes that banks are being forced into more conservative lending practices.

A big chunk of the positive momentum in house prices in recent years stemmed from investor-borrowers, and there appears to be a direct link to higher LTI loans with both sellers and buyers in this particular bracket enjoying high LTI mortgages.

JP Morgan is predicting credit growth slowing from 6% annualised to 4% over three years. This seems like a gradual, relatively small contraction, but the impact could be significant. Consider the following maths: High LTI loans represent around 10% of total volume in new loans, but because of their above-average size, JP Morgan believes these loans represent maybe 31% of all new lending in dollar terms. JP Morgan is not predicting a crash in house prices in Australia, but a noticeable slowdown in overall activity, which translates into lesser demand for credit. A crash requires forced sellers.

Related effects of a credit slowdown

The outlook for banks has not looked as clouded since the global financial system froze in 2008, and this is understandably turning the sector into one of the major laggards in the local share market. Investors holding shares in discretionary retailers should also better prepare for tougher times ahead. This is a slow going, long drawn out process and with little in the way of a sizeable increase in average wages, I'd be inclined to think the overall landscape for consumer spending will remain subdued for a lot longer than the optimists expect.

 

Rudi Filapek-Vandyck is an Editor at FNArena. FNArena’s service can be trialled for two weeks at www.fnarena.com. This article has been prepared for educational purposes and is not meant to be a substitute for tailored financial advice.

2 Comments
Marvin Cathey
June 07, 2018

Mmmm... Not a terribly helpful analysis. Why doesn't he use his own words and say "Sell the banks get out now at any price."
Bank share prices have fallen substantially. Bank profit growth will be constrained for a period of time but online technology uptake, reduced staff numbers, reduced physical bricks and mortar branches will be an offset.
Safe reliable banks are a necessary central core to facility commerce. If banks are not sufficiently profitable they will go broke.
Following this to its logical conclusion could mean we don't have independent banks in the future but a single direct government owned and run "bank" controlling commerce. A quasi government department. Why not combine it with the ATO. And we all know what dealing with a government department is like. Ask the minister for Centrelink. "It takes 57 minutes before the phone is answered at Centrelink presently (THAT'S ON THE RARE OCCASIONS YOU CAN GET A PHONE LINE TO RING). The minister seems to think that was a good result as last year the wait was over an hour!!!
Some would argue that post Royal Commissions our banks could be so bound up with red tape that they become virtual government departments anyway.
So don't bash the bank to hard as we may end up with something far worse than we have now.

Fundie
June 07, 2018

We should recognise that fully-franked dividends cover a decent fall in share price from these levels. By my calcuations, F/F dividends are ANZ 8.6%, BOQ 11.9%, CBA 8.9%, NAB 10.7%, WBC 9.8%.

 

Leave a Comment:

     

RELATED ARTICLES

3 key risks: banks are too big to behave badly

The sorry tale of our big banks

The forgotten asset class set to outperform in 2022

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

With the Coalition losing the 2022 election, its policy to allow young people to access super goes back on the shelf. But lowering the downsizer age to 55 was supported by Labor. Check the merits of both policies.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 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.