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18-10-2014, 08:19 AM
In Singapore, there are big 3. Down Under there are big 4 plus smaller regionals. Together, they share similarities - decent yielding and big components of mkt index...
Can you still bank on the banks?
PUBLISHED: 5 HOURS 34 MINUTES AGO | UPDATE: 2 HOURS 20 MINUTES
While the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent. Illustration: Michael Mucci
KAREN MALEY
As worries about spluttering global growth echo through global markets, investors around the world are being forced to question whether they should continue to own bank shares.
After all, if the global economy slumps back into recession and companies are hit with falling sales, the world’s big banks will be hit with a steep jump in problem loans. Then there are the huge losses they could run up on the billions of dollars lent to investors to play the rise in asset prices engineered by central banks. Investors in the big four Australian banks – which together account for a staggering 29 per cent of the ASX 300 – have seen the value of their investments fall by up to 10 per cent in six weeks.
As Perpetual’s head of investment market research, Matt Sherwood, points out, “Australian banks may be among the most consistent earnings and income growth stocks in the market, but they are not immune to corrections, economic shocks or risk.” And he says investors are wrong to believe they can diversify by owning shares in all four banks. They “tend to move in a pack” and “have the same impact from changes in interest rate settings, higher unemployment, greater regulation and any general economic downturn”.
Hugh Harley, financial services leader at PwC, also has reservations.
“Global over-leverage, which took 20 or 30 years, was always going take a long time – maybe 10 or 15 years – to build down.
“So any long-term view of banks needs some caution.”
But investors are obsessed with more immediate risks. They’re worried the financial system inquiry led by David Murray will recommend the big four be forced to hold more capital; this would reduce their returns on equity. Last month, UBS’s banking research team estimated increasing the risk weighting on the major banks’ home loan books and requiring them to hold a bigger capital buffer could force them to hold an additional $41.1 billion in capital.
As Perpetual’s Sherwood points out, “The banks are now facing significant headwinds. There’s clearly regulatory risk coming as the G20 moves to force the world’s top banks to boost their total loss absorption capital.”
And the economic backdrop is deteriorating. “The Australian economy is subdued and unemployment is near decade highs, so it will be increasingly hard to maintain bad and doubtful debts at their recent decade low, despite current interest rate settings providing more protection for borrowers.”
A final risk is that banks will not be able to sustain their payout ratios.
“Banks have boosted payout ratios to about 75 per cent – way in excess of international peers and unsustainable, as it would require bad loans to remain at historic lows.”
Sherwood argues the banks have been in a “sweet spot” for three years, but that this has passed. “They’ve benefited from record low rates and the search for yield, the domestic economy has been strong enough, and they’ve been able to lift their payout ratios. But this is likely to be as good as it gets – even though they’re sound and robust businesses that have performed well for domestic investors for the best part of a quarter century.”
YIELDS ABOUT 6 PER CENT
But while the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent, a level where even highly regarded fund managers find them tempting.
In a report note this week, Goldman Sachs argues that record low rates have eased debt-servicing costs for households and they predict “the low level of bad debts can be sustained for the next couple of years”. The major banks “are well positioned to meet any higher capital requirements” that the Murray inquiry might recommend. “While we expect uncertainty around capital levels may continue to weigh on sector valuation multiples until at least the G20 in November 2014 (the first key catalyst where we may get a better sense of where global regulators are moving to), we think the sector is looking attractive [on] domestic relative valuations,” the report says.
”This is particularly the case given our strategy team believes the downside risk for bank earnings is lower than the non-bank industrials over the next 12 months.”
What’s more, it argues, Australian banks are looking more attractive compared with their international peers. “In a global context, valuations for the major Australian banks are looking as relatively attractive as they have in about two years.”
But UBS analysts are more sceptical. They say banks’ cost of capital is about 9.3 per cent, compared with the implicit cost of capital in bank share prices of about 10.1 per cent, given forecast return on equity of 16.2 per cent. “This implies the banks are around 9 per cent cheap, or one standard deviation from historical average. This has usually been a ‘buy’ signal for the banks.”
But they note this calculation is dependent on bond rate movements and assumptions about bank returns. Using a bond rate of 4 per cent – and assuming after the Murray inquiry the banks’ return on equity will fall to about 15 per cent – they estimate banks are still around 5 per cent expensive.
One reason investors continue to bank on the banks is that they have demonstrated an impressive ability to adapt to changing circumstances. As PwC’s Harley says: “We know Australian banks are well managed and that the combination of market structure and business model gives plenty of flexibility for banks to respond as market circumstances change. That is very clear from the last five years.”
Perpetual’s Sherwood notes the banks enjoy a position of market dominance, which makes it hard for new entrants to compete. “We re seeing some big companies using their balance sheets to try and gain market share in some areas, such as insurance and credit cards. But the banks are very dominant in their primary industry.”
Thus Australian investors are unlikely to desert the banks in droves. “Retail investors are more likely to view the price decline as a reason to get buy more. Given their massive performance, it’s hard to see investors walking away and looking elsewhere.”
The Australian Financial Review
BY KAREN MALEY
Karen Maley
Karen Maley blogs on markets from our Sydney newsroom.
@KarenMaley
Can you still bank on the banks?
PUBLISHED: 5 HOURS 34 MINUTES AGO | UPDATE: 2 HOURS 20 MINUTES
While the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent. Illustration: Michael Mucci
KAREN MALEY
As worries about spluttering global growth echo through global markets, investors around the world are being forced to question whether they should continue to own bank shares.
After all, if the global economy slumps back into recession and companies are hit with falling sales, the world’s big banks will be hit with a steep jump in problem loans. Then there are the huge losses they could run up on the billions of dollars lent to investors to play the rise in asset prices engineered by central banks. Investors in the big four Australian banks – which together account for a staggering 29 per cent of the ASX 300 – have seen the value of their investments fall by up to 10 per cent in six weeks.
As Perpetual’s head of investment market research, Matt Sherwood, points out, “Australian banks may be among the most consistent earnings and income growth stocks in the market, but they are not immune to corrections, economic shocks or risk.” And he says investors are wrong to believe they can diversify by owning shares in all four banks. They “tend to move in a pack” and “have the same impact from changes in interest rate settings, higher unemployment, greater regulation and any general economic downturn”.
Hugh Harley, financial services leader at PwC, also has reservations.
“Global over-leverage, which took 20 or 30 years, was always going take a long time – maybe 10 or 15 years – to build down.
“So any long-term view of banks needs some caution.”
But investors are obsessed with more immediate risks. They’re worried the financial system inquiry led by David Murray will recommend the big four be forced to hold more capital; this would reduce their returns on equity. Last month, UBS’s banking research team estimated increasing the risk weighting on the major banks’ home loan books and requiring them to hold a bigger capital buffer could force them to hold an additional $41.1 billion in capital.
As Perpetual’s Sherwood points out, “The banks are now facing significant headwinds. There’s clearly regulatory risk coming as the G20 moves to force the world’s top banks to boost their total loss absorption capital.”
And the economic backdrop is deteriorating. “The Australian economy is subdued and unemployment is near decade highs, so it will be increasingly hard to maintain bad and doubtful debts at their recent decade low, despite current interest rate settings providing more protection for borrowers.”
A final risk is that banks will not be able to sustain their payout ratios.
“Banks have boosted payout ratios to about 75 per cent – way in excess of international peers and unsustainable, as it would require bad loans to remain at historic lows.”
Sherwood argues the banks have been in a “sweet spot” for three years, but that this has passed. “They’ve benefited from record low rates and the search for yield, the domestic economy has been strong enough, and they’ve been able to lift their payout ratios. But this is likely to be as good as it gets – even though they’re sound and robust businesses that have performed well for domestic investors for the best part of a quarter century.”
YIELDS ABOUT 6 PER CENT
But while the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent, a level where even highly regarded fund managers find them tempting.
In a report note this week, Goldman Sachs argues that record low rates have eased debt-servicing costs for households and they predict “the low level of bad debts can be sustained for the next couple of years”. The major banks “are well positioned to meet any higher capital requirements” that the Murray inquiry might recommend. “While we expect uncertainty around capital levels may continue to weigh on sector valuation multiples until at least the G20 in November 2014 (the first key catalyst where we may get a better sense of where global regulators are moving to), we think the sector is looking attractive [on] domestic relative valuations,” the report says.
”This is particularly the case given our strategy team believes the downside risk for bank earnings is lower than the non-bank industrials over the next 12 months.”
What’s more, it argues, Australian banks are looking more attractive compared with their international peers. “In a global context, valuations for the major Australian banks are looking as relatively attractive as they have in about two years.”
But UBS analysts are more sceptical. They say banks’ cost of capital is about 9.3 per cent, compared with the implicit cost of capital in bank share prices of about 10.1 per cent, given forecast return on equity of 16.2 per cent. “This implies the banks are around 9 per cent cheap, or one standard deviation from historical average. This has usually been a ‘buy’ signal for the banks.”
But they note this calculation is dependent on bond rate movements and assumptions about bank returns. Using a bond rate of 4 per cent – and assuming after the Murray inquiry the banks’ return on equity will fall to about 15 per cent – they estimate banks are still around 5 per cent expensive.
One reason investors continue to bank on the banks is that they have demonstrated an impressive ability to adapt to changing circumstances. As PwC’s Harley says: “We know Australian banks are well managed and that the combination of market structure and business model gives plenty of flexibility for banks to respond as market circumstances change. That is very clear from the last five years.”
Perpetual’s Sherwood notes the banks enjoy a position of market dominance, which makes it hard for new entrants to compete. “We re seeing some big companies using their balance sheets to try and gain market share in some areas, such as insurance and credit cards. But the banks are very dominant in their primary industry.”
Thus Australian investors are unlikely to desert the banks in droves. “Retail investors are more likely to view the price decline as a reason to get buy more. Given their massive performance, it’s hard to see investors walking away and looking elsewhere.”
The Australian Financial Review
BY KAREN MALEY
Karen Maley
Karen Maley blogs on markets from our Sydney newsroom.
@KarenMaley
