Banks and financials outlook 2013

Nicholas Grove  |  20/12/2012Text size  Decrease  Increase  |  

Nicholas Grove: The Morningstar equities research team recently released the Huntleys' Forecast 2013 sector reviews. Here to give investors an idea of what to expect from the banking and financials sector in the coming year, I am joined again by Morningstar sector head David Ellis.

David, thanks very much for your time today.

David Ellis: Thanks Nick, my pleasure.

Grove: First of all David, what are going to be the key macro issues, both domestic and international, that investors need to keep an eye on when it comes to this sector in 2013?

Ellis: Well, the key domestic macro issue is economic growth and the strength or lack of strength in Australian GDP for 2013 and even into 2014, as the massive mining investment boom is slowing down, and the concern is that it's slowing down faster. And when it reaches its peak, the pressure on the non-resource parts of the economy is expected to increase, and on the high Australian dollar and the flow-on effects of that combined with the federal government tightening their fiscal position. That means the GDP growth in 2013 will probably be slower than expected, and that will have a clear impact on the financial services sector, particularly the banks.

As far as internationally, the key things we're looking for internationally of course is, first of all, the US fiscal cliff negotiations are rapidly drawing to - hopefully - rapidly drawing to a close. If that goes badly, that will probably have a quite a significant negative impact globally on global equity markets, and conversely.

So, if there is some negotiation agreed between the two political parties in the US, well then that'll probably have a short-term positive impact on equity markets. Other global macro issues, of course, are the economic growth outcomes in China, and the flow-on effect for demand and price of commodities - particularly iron ore and coal which obviously impacts the Australian economy.

Grove: David, what do you expect from the big four banks in terms of earnings and dividends in the year ahead? And do you still expect a return of surplus bank capital to shareholders in the form of special dividends, buybacks or payout ratios in 2013?

Ellis: Yeah. Our position hasn't changed since the last time we spoke and that is for moderate credit growth, which will flow through to moderate revenue growth. There is an increasing focus and emphasis on improving the cost base of the banks. So, in relative terms, we'll see costs being reduced. And margins of course - net interest margins - are a major swing factor.

And over the last month or so, we've seen wholesale funding costs actually come down. Now, that has a longer, flow-on impact on net interest margins that's definitely not immediate by any stretch of the imagination. So, margins we expect will stay relatively stable. The big swing factor for bank earnings are bad debts, and that gets back to my first point or to your first question about he economy. If we see a sharp decline in the economy, an increase in unemployment, then we will see an increase in bad debts, particularly for business and commercial loan bad debts.

If we see a sharp increase in bad debts, well, then we'll see bank profits being under pressure. That's not our central case, that's not our main thesis. We expect the economy to muddle through and we wouldn't be surprised if bad debts do increase, but not materially.

And so, getting back to thesis or forward-looking thesis of capital returns or higher dividends, at this stage we're comfortable that the banks will continue to increase their capital base. They will have surplus capital, particularly Westpac, and probably CBA. And assuming the economy doesn't deteriorate sharply, then we expect to see capital returns to shareholders in the next 12 to 18 months and it may be in the form of special dividends or it could be share buybacks.

Grove: Stepping away from the banks for a minute, what sort of performance can we expect from the big insurers in 2013?

Ellis: Well, that's a tougher question. The insurers obviously are impacted by a lot of factors, not the least being the incidence of natural disasters and catastrophes. And in 2011 and 2012, we have seen a sharp increase in catastrophes around the world, which have impacted QBE severely, and to a lesser extent IAG and Suncorp.

Insurance premiums are increasing, which is a positive for profitability. There is better underwriting discipline. Reinsurance costs are going up, but we do expect to see a solid improvement in earnings for the three insurers, particularly QBE.

Grove: Finally David, how do you expect the wealth managers and the diversified financials to perform in 2013?

Ellis: Well, the wealth managers and the diversified financials are influenced heavily by equity market activity and strength, so they are leveraged to the markets. So, if we see a continued recovery in equity market values, well it'll do two things - one it'll increase the market value of funds under management, which will increase fee income for the wealth managers. But more importantly, we want to see a return of confidence from investors to start putting more money into the equity market, either directly or through managed funds. A lot of that money is currently seeking cash deposits with the banks.

So, if we see a recovery in confidence in the market, we will see a recovery in net flows into the listed wealth managers. We see a similar sort of outlook too for the property sector. Whilst a lot of the property stocks have run quite hard over the last six months, the last 12 months, we're pretty confident in underlying asset values, property values, and we expect further investor demand for those higher-yielding, quality, income-producing property trusts.

Grove: David, thanks very much for your time today.

Ellis: It's a pleasure, Nick.

Video Archive...

Shifting fortunes for ANZ, more of the same for CBA in 2017
12/01/2017  Australian banks are well-positioned as they head into 2017, with ANZ moving from least profitable in 2016 to become one of the sector's top performers and CBA remaining an investor favourite.
Is Trump a threat to emerging markets?
12/01/2017  Is President Donald Trump a threat to emerging market returns? Paul Jackson from the UK-based Source ETF considers the outlook for sector and where investors can find the best opportunities.
Platinum, Aussie banks and Peter Warnes among top interviews of 2016
22/12/2016  We look back on some of our most notable interviews of the year, as Morningstar analysts and external experts helped us delve into some of the biggest events that shaped Australian and global markets in 2016.
Oil price finds sweet spot, while mining hits rock bottom
20/12/2016  The rise in oil prices should see improved performances from Australian producers in 2017, while mining services companies will continue to struggle amid weaker Chinese demand, says Morningstar equity analyst Mark Taylor.
How Greek mythology can make you a better investor
07/12/2016  Don't be over confident or follow the herd, and like Odysseus, learn to have yourself "tied to the mast" when it comes to long-term investing.
Supermarket headwinds prompt fair value cut for majors
06/12/2016  Growing competitive pressures and a declining revenue outlook for Australia's two grocery giants now look to be part of a longer-term, structural shift.
What returns should you expect from markets?
01/12/2016  As market risks rise, investors must adjust their profit expectations--gone are the days of 8 per cent returns. But there are still growth opportunities out there if you know where to look.
Why healthcare stocks got a bump from Trump
28/11/2016  Australian healthcare and pharmaceutical companies continue to enjoy a purple patch, and for various reasons including the recent US election result, explains Morningstar's healthcare equities analyst Chris Kallos.
Equity and hybrid investors react as bond prices tumble
24/11/2016  The negative correlation between bonds and equities is reasserting itself following the US election of Donald Trump, according to John Likos, Morningstar's senior credit analyst.
2 global themes that are finding favour among ETF investors
15/11/2016  Australian retail investors are increasingly turning to ETFs for specific tactical exposures to global themes, particularly in the context of large-scale market events such as US election 2016.
Maintain discipline and stick to fundamentals when selecting stocks
14/11/2016  Steer clear of fads, maintain a disciplined approach and focus on company fundamentals in building and maintaining your investment portfolio, says Anton Tagliaferro, investment director, Investors Mutual
How Trump could impact economic growth
10/11/2016  Slowdowns in trade and immigration could hold back the US, and infrastructure spending could boost GDP, but it's too early to make any major changes to our economic forecast, says Morningstar's Bob Johnson.
President Trump: What should you do?
10/11/2016  Donald Trump has beaten Hillary Clinton to become the 45th US president. What should investors do?
Software companies worth watching amid tech deployment phase
08/11/2016  Kate Howitt, portfolio manager at Fidelity International discusses some of the core phases in technological disruption and identifies software companies among those currently presenting opportunities.
Kerr Neilson hot, cold and tepid on Europe, US and China
07/11/2016  Platinum co-founder and CEO Kerr Neilson explains his views on the major global markets and outlines where he sees opportunities--and where he doesn't.
Is Inghams a moat-worthy investment?
02/11/2016  Morningstar's Ravi Reddy discusses the upcoming float of poultry product producer Inghams, and whether it's in investors' interests to subscribe for shares in the IPO.
3 best ideas in healthcare
26/10/2016  Morningstar's Chris Kallos looks at some of the most compelling ideas in Australian healthcare, while also reaffirming the importance of the uncertainty rating and how it pertains to the sector.
Exercise caution and let some cash build
24/10/2016  Morningstar's Peter Warnes provides a near-term outlook for equities markets, while also sharing his thoughts on the upcoming Ingham's IPO.
Bogle forecasts low stock and bond market returns
21/10/2016  Warning of "much lower market returns" ahead, Vanguard founder Jack Bogle urges investors to seek low-cost investment products. From Morningstar US.
Finding the right flavour ETF amid expanding ETP menu
13/10/2016  From a relatively vanilla selection of exchange-traded funds (ETFs) on offer in the early 2000s, Australian investors can now choose from a wide range of exchange-traded products to suit various tastes.