CLSA: Bank perfection never lasts

CLSA’s Brian Johnson is the probably the best bank analyst in the country. His latest take is well worth your reading.

Having sat through the recent Australian bank reporting season we sensed a potentially dangerous degree of “optimism in perpetuity” with management expecting loan losses to stay low and a seeming increase in regulatory capital targets a mere distraction. That said we also noted consistent NIM declines given (i) the beginnings of a potential price war as the banks reduce incremental loan pricing to gain market share in a low system credit growth environment, (ii) the NIM dilutionary impact of increased holdings of low yielding High Quality Liquid Assets, and (iii) lower interest rates reducing the rates of returns on free funds.

As detailed in our previous sectoral reports Australian bank share prices continue to be driven by the macro environment rather than stock specific micro factors – in particular the global distortions from Quantitative Easing (refer Australian Banks (QE teeter totter: To QE-ternity and beyond!) . As detailed in Figure 1 QE –

  • inflates Australian bank earnings (low loan losses, writeback gains, positive CVA, positive marks in trading books),
  • alleviates concerns about structural deposit shortfalls,
  • reduces regulatory capital intensity allowing dividend payouts to expand (pro-cyclicality, asset optimisation, low loan losses), and
  • reinforces investor preferences for income over growth with Australian banks likely both the biggest source of structural benchmark deviation for underweight international investors but also the source of highest dividend yields.

Conversely the prospect of QE-ternity (with Japan joining the club) could yet see the attractive Australian bank dividend yields (~5%) narrow even further towards the QE compressed domestic 10 year bond rate (~3.8%) (refer Figure 2).

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In this macro-environment we retain our Neutral sectoral stance but caution investors should not kid themselves these stocks are trading at peak cycle PEs, on peak cycle earnings (low losses / writeback gains), capital intensity is rising and so is management complacency (ie GOAT)!

As detailed in Figures 3 and 4 “There is no-one more dangerous than a banker with no memory” – the FY07 to FY09 experience suggests that at some point QE-exit would smash Australian bank earnings, EPS and DPS(look at May 2012 at what even a whisper of QE-exit did to the Australian banks ie USD declines of >20% in 20 trading days! refer Figure 5).

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David Llewellyn-Smith
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Comments

  1. Pretty fair analysis actually. There is certainly a price war beginning to gain market share in a market with modest net lending growth. We are closing in on US lending rates.

    Bank shares have been a fabulous hold but going forward it’s hard to see them driving the same rate of growth when net lending has slowed and there is no ability to ramp it up to past growth levels.

  2. Most banks lose corporate memory within 10 years.

    The 25 year olds that get into positions of approval at 35 weren’t senior enough in most cases to be involved in working through the defaults in the recession when they were 25.

    The conservative lending officers who went through the recession eventually get pushed aside after marketers get enough history of declined loans done by someone else and repaid that they can prove the credit officers are out of touch with the new environment/great moderation.

    The projects and companies that sought loans that were declined have gone from strength to strength, proving the credit officers were idiots.

    Also the lagging banks lose markte share to the aggressive banks and the senior executives realise that they are getting big career risk for losing market share, so they increase market share (ie approval of loans that will default in a recession) to reduce career risk.

  3. Govt sponsors perpetual housing price growth, ( FHB, Foreign visas, Neg gearing, RMBS purchases , ever lower cash rates, crisis bail outs ) together with mandated Super contributions , why would you invest in any other industry.