The Big 4 Banks continue to hold a place in many retail investors’ portfolios. With attractive dividend yields, high profitability and a balance sheets better than most developed nations on earth, it stands to reason that many income-seeking investors have a Bank or two (perhaps all four) in their portfolio.
But, in the lead up to this reporting season (March – September), Bank investors who had for some time found themselves in a state of inertia, comfortably taking their dividends without the need to do much else, have been woken from their slumber. In light of the findings of the Royal Commission, new executive teams at the helm and a struggling operating environment, investors have had to become more proactive and selective with the banks they hold. While all of them continue to have their growth challenges, from a dividends and operational perspective, there are some stark differences.
Australia and New Zealand Banking Group Limited (ANZ)
Following the latest report, ANZ remains our favoured bank amongst the majors regarding the sustainability of its dividend and overall capital position. Overall the 2% growth in cash profits was in-line with market expectations. The bank’s institutional division performed well; however the retail arm continues to deliver modest results in a competitive environment providing a slight dampener on what was an otherwise solid result.
As has been the case for some time, revenue headwinds remained, falling 9%. Net interest margin (NIM) dropped in 2H18 on the previous half from 182bps to 180bps primarily due to its Global Markets balance sheet restructuring and customer remediation. Pleasingly ANZ has taken steps to improve its capital position lifting its Common Equity Tier one (CET1) ratio to 11.5% and achieving cost efficiencies via its simplification strategy. Maintaining its dividend at 80 cents, and with a forward dividend payout ratio of ~69%, it is well placed to maintain its dividend at current levels.
Commonwealth Bank of Australia Limited (CBA)
As has come to be expected, the Bank did provide a quarterly update as it reports a June-December cycle. This update did throw up some surprises. The company’s CET1 ratio was softer than expected dropping 10.3%. This is not seen as a long-term issue as the latest period included a large dividend payment and the imminent divestment of CommInsure Life, expected by the end of 2019, will see the Bank comfortable meet its 10.5% target.
Cash earnings excluding remediation costs fell by 9% on the quarter, revenue fell by 4% and costs rose by 1%. Pleasingly they have been able to lift revenue from core markets such as deposits, home and business lending and the company remains committed to meeting its target of becoming, “a simpler, better bank.” Interestingly of all the four, the CBA had the highest Loan Impairment Expense relative to gross loans and acceptances of 17bps, an increase of 2bps. This driven in large part due to challenges created by low wages growth and cost of living pressures on consumers.
National Australia Bank Limited (NAB)
Leading into their report, the NAB was the only one of the Big 4 that was not a Lincoln Star Income Stock. We had earlier turned sour on the investment thesis for several different reasons. In particular, our expectation that the dividend would be cut, the relatively weaker capital position, delay in the divestment of assets and management instability.
Unfortunately, the latest report confirmed these fears. The dividend was cut by 16% to 83 cents, NAB’s CET1 sits at 10.4%, maintains its dilutive DRP and partially underwrote the dividend distribution (circa $1bil) to meet the 2020 deadline.
We do acknowledge the strong result from the business and institutional divisions, as well as the fact the future dividend is now more sustainable with an expected payout ratio of 77%. But with little in the way of progress in the sale of its wealth arm MLC and no new long-term CEO appointed as of yet, we continue to see elevated active risks and NAB continues to be our least preferred of the big 4.
Westpac Banking Corporation Limited (WBC)
WBC delivered a result that was in line with market expectations, with cash earnings falling 5% on the pcp and revenue down 10%. The fall in cash earnings coupled with a flat dividend of 94 cps has led to a rise in the payout ratio to ~80%, above its historical average level. The company will need to generate positive earnings growth in FY20 to keep the current rate sustainable. The company by its own admission wasn’t that optimistic on the local economy and expected mortgage growth rates to continue to fall by 2.5%. That said, of all the banks its Loan Impairment Expense relative to gross loans and acceptances came in the lowest at 9bps (next was ANZ at 13 bps) leaving some to think Bank may be too optimistic. Pleasingly, they have their eye on continuing to cut costs and with a CET1 ratio at 10.64%, above APRA’s requirements of 10.5%, it remains well capitalised, hence we have decided to retain WBC as a Star Income Stock for the moment.
A final word on Impairments and credit quality
With the challenges in the property market seeing prices fall in recent times, it may come as some surprise to learn that bad debts, and credit quality across all the banks that reported was still very strong. Some have pointed to a disconnect between the low level of impairment charges to average loans recorded this period and the current weakening property market.
In our view, the property sector as an investment is in for a challenging time, though we don’t expect a systemic collapse. Given the structure of loans, tighter recent lending policies, interest rates remain low, and strong employment levels, we feel the reported numbers are appropriate at this stage – though this could change quickly should economic conditions worsen or interest rates spike.
* The Commonwealth Bank of Australia (CBA) do not report within the Mar-Sep cycle. Data is at their December interim result
ELIO D’AMATO (@Elio_DAmato)
Elio D’Amato is the Executive Director at Lincoln indicators, a leading boutique fund manager and creator of Stock Doctor the complete share market research platform. www.lincolnindicators.com.au