Leading into the latest bank reporting season, many observers were worried.
Concerns for the big 4 centred around a slowing housing market, increasing competition and the possible fall out from Royal Commission related issues. This in direct contrast to Macquarie Group (MQG) who had a strong level of expectation baked into its price and therefore needed to impress on the upside to sustain its price levels.
By now most readers will know that the bank reporting season was above expectations, except for the Commonwealth Bank of Australia (CBA) whose quarterly update showed the strain of increased regulation. But for those that did report, the clear message from the reporting season was that the banks are taking appropriate measures to adapt to a more regulatory intensive and lower growth environment.
From a bottom-up perspective, all the banks remain in Strong Financial Health and continue to exhibit accounts more stable than most developed nations. All look on track to meet the 2020 deadline to hold APRA’s Common Equity Tier 1 (CET1) ratio target of 10.5%, with ANZ exhibiting the strongest capital levels at 11%. CBA and National Australia Bank (NAB) are more dependent on the divestment on non-core assets to reach the target level, with CET1 ratios of 10.1% and 10.2% respectively. The banks are also benefitting from pristine credit quality as impairment charges continue to remain at historically low levels. Therefore, our banks are exposed to acceptable levels of financial risk.
Return on Equity (ROE)
The days of strong double-digit growth for the banks have been well and truly behind them for quite some time. However, investors would have been heartened that on a pre-tax basis, the ROE from their investments remained stable. A stronger focus on cost control and lower impairment charges generally improved the bottom line. MQG displayed the largest expansion in ROE as it rose to 19% due to higher levels of operating income and a lower expense ratio and tax rate. The exception was ANZ where following recent asset sales, ROE declined over the period.
Net Interest Margin (NIM)
NIMs measure the interest income generated versus the amount of interest paid out to their lenders. The outperformer was Westpac Banking Corporation (WBC) who increased its underlying NIM 7bps on 2H17 to 217bps, reflecting higher treasury income and the full effects of the earlier repricing of investor and interest-only loans. Though the results were solid across all banks, each referred to the rising cost of wholesale funding as a risk to margins in the near-term.
All the banks were able to maintain a stable dividend this period, though MQG lifted its full-year dividend by 11.7% to $5.25. Pleasingly ANZ and WBC joined MQG in being placed within their respective stated dividend payout ranges. Pleasingly, both ANZ and MQG had already initiated share buyback programs with plenty of headroom for further capital management programs. All dividends were fully franked, with the exception of MQG which was franked at 45%. Of some concern was NAB, who maintained an elevated payout at 81% of adjusted cash net profit with a capital position. Though confident they can support this through the cycle, we will watch closely for points of strain.
Following the reports, we are happy to retain each of the banks as Star Income Stocks[i]. Each delivered standout results relative to expectations, with the exception of NAB who offset their sluggish performance with the news that it will sell its wealth management arm.
From an investment perspective, the bank’s earnings growth challenges have been evident for some time. However, for income-seeking investors who value their consistent and stable fully franked dividend payments, each remains a staple holding.
Investors seeking more dynamic double-digit growth stories will need to continue to look elsewhere, however, of the current cohort, MQG offers the most optimistic long-term growth outlook.
From here on in, without an immediate catalyst for dynamic business growth, banks will continue to be range bound as they have been for the past few years (with the exception of MQG.) Therefore, investors will need to continue to bank on the dividends as their major source of earnings. Something that we are comfortable with following their reports this season.
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CBA provided a quarterly update. It is due to report their full set of accounts in August 2018
Prices as at 08 May 2018
MQG is a 2nd tier bank and subject to a 10% CET1 ratio by 2020