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...

How climate change will impact your portfolio
20/04/2017  Ignore climate change at your portfolio's peril, says Jeremy Grantham, founder of asset manager GMO.
How dwindling resources will push up commodity prices
13/04/2017  Jeremy Grantham, renowned investor and founder of GMO, explains how a growing population is putting a strain on global resources.
How retirement spending affects withdrawal rates
10/04/2017  Data shows that the withdrawal rate gets higher as spending decreases in retirement, says Michael Kitces, a US-based financial planning expert.
What lies ahead for mining and materials
10/04/2017  Iron ore, coal, lithium, and uranium: some end-markets will rise and others will fall behind, says Morningstar commodities and resources analyst David Wang.
The evolution of multi-asset investing
07/04/2017  More difficult market conditions in a rising interest rate environment highlight the value of active management across your portfolio, says Simon Doyle, Schroders' head of fixed income and multi-asset.
When is the right time to buy stocks?
29/03/2017  Davis' Associates Chris Davis says the best time to invest is when you have the money, and to ignore market "noise".
How misinterpreting risk impacts financial returns
28/03/2017  Dr Gerd Gigerenzer says fund providers need to invest in education so that savers are better equipped to deal with risk--and can make better financial decisions.
Are European stocks overvalued?
27/03/2017  Isabel Levy of French asset manager Metropole Gestion explains how she uses fundamental industrial analysis to avoid value traps and identify the fair value of European equities.
Which funds are worth paying for?
23/03/2017  High active share funds--that is, those managers who take off-benchmark bets--outperform those which are low active share. So, ban closet trackers from your portfolio.
Bond market wobbles no cause for panic
21/03/2017  Australian bonds see only a slight tremor in response to the Fed's rate rise, says John Likos, Morningstar's senior credit analyst, who also provides insights on the new, and anticipated, hybrids from Australian banks.
ESG: Essential steps for successful long-term investing
21/03/2017  Want sustainable long-term returns? Morningstar UK reveals the essential components and the fund providers who are getting it right.
Few values left in global stock market
20/03/2017  Morningstar's directors of equity research think investors need to be cautious in the market today and offer some of their best investment ideas.
Why the time is right to invest in emerging markets
20/03/2017  Hilde Jenssen from Norwegian fund manager Skagen admits that emerging markets have disappointed investors over the past three years--but says valuations are attractive and reforms are boosting returns.
Johnson: Fed's path may not be smooth
16/03/2017  The Fed's plan for stair-step rate hikes in the coming years will likely be derailed by economic reality, says Morningstar's Bob Johnson.
First-half 2017 earnings season insights
15/03/2017  Companies produced reasonably good results overall with only a few standouts, even as a cost-out theme dominated, says Peter Warnes, head of equities research, Morningstar.
The growing appeal of LICs
06/03/2017  The popularity of listed investment companies is on the rise once again, but there are several things investors need to be aware of before buying in, explains Michael Malseed, Morningstar senior analyst, manager research.
Earnings season wrap: BHP exercises good cost control
27/02/2017  As the curtains close on the 1H17 reporting season, BHP books earnings that are slightly softer than expected, while Woolies takes market share at the expense of margins.
Possible $2.5bn tailwind to drive hybrid demand in 2017
22/02/2017  Strong supply dynamics and ongoing economic stability should create significant opportunities for hybrid investors in 2017, according to John Likos, senior credit analyst, Morningstar Australia.
Earnings season wrap: Telstra feels competitive heat
17/02/2017  As the 1H17 earnings season rolls on, Wesfarmers posts a bumper profit, Newcrest restores its interim dividend, while Telstra's profit falls as it feels the heat of intense competition.
Earnings season wrap: Rio Tinto's dividend surprises
10/02/2017  Rio Tinto delivers a surprise full-year payout of US$1.70, NAB records a soft first quarter, and CIMIC posts an annual net profit in line with Morningstar's expectations.