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...

Where to shop for quality stocks
31/08/2015  Morningstar's Peter Warnes gives his take on the recently concluded earnings season and gives investors some advice for coping with the recent volatility.
What now for China-exposed ETFs?
27/08/2015  Morningstar’s Alex Prineas discusses the growth of the ETF market and what the China market turmoil means for the A-Share ETFs.
Market overreacting to China news
26/08/2015  The depth of the market sell-off isn’t justified by the data out of China, says Morningstar’s Francisco Torralba
What to make of the market mayhem
25/08/2015  As the market focuses on China and the Fed, investors should keep an eye on the long term.
QBE emerges from rough patch
19/08/2015  As the fiscal 2015 earnings season rolls on, Morningstar's Peter Warnes gives investors his view on results from QBE, ANZ and Newcrest, while also sharing his thoughts on the Asciano takeover.
Telstra makes a statement
14/08/2015  Morningstar's Peter Warnes gives investors his take on the full-year results from the likes of Cochlear, CSL, the Commonwealth Bank and Telstra.
Introducing Morningstar's new fund screener
13/08/2015  Quality fund managers across a range of asset classes can now be easily selected using Morningstar's new fund screener.
What are the priorities for retail shareholders?
11/08/2015  The Australian Shareholders’ Association will be keeping a close watch on the current reporting season to ensure companies are balancing growth with regular dividend payments.
Introducing Morningstar's new stock screener
04/08/2015  Morningstar's new stock screener allows exclusive access to our analyst ratings, including recommendation, economic moat, stewardship and fair value uncertainty ratings.
An insight into the Chinese market fall
31/07/2015  The Chinese market has been on a rollercoaster ride over the past year, particularly in recent weeks.
How safe are the banks? Part 2
24/07/2015  Mortgage risks, new capital requirements and the role of technology giants in the provision of payment systems continue to pose challenges for the big banks.
How diversified is your portfolio?
23/07/2015  Morningstar’s Tim Murphy talks about an effective investment tool that helps investors achieve a diversified portfolio.
Identifying quality fund managers
20/07/2015  Morningstar’s Kathryn Young discusses the key attributes behind a quality investment manager and why past performance is not a good indicator of future performance
Your Money Weekly Forecast 2015-16
17/07/2015  Morningstar's Peter Warnes discusses the Your Money Weekly biannual Forecast and what investors can expect as they head into the new financial year.
How safe are the banks?: Part 1
14/07/2015  A closer look at the strengths and weaknesses of bank profits around the world following Morningstar’s recent study on the sector.
What the new ETFs mean for investors
09/07/2015  Investors are urged to drill down and understand the strategy behind the plethora of new ETFs coming into the market.
Introducing new stock charts
01/07/2015  Get an in-depth analysis of a stock using Morningstar's new powerful chart tool including company and benchmark comparisons.
5 big market themes
30/06/2015  Investors should watch the velocity of rate increases, keep Greece in perspective, and mind diversification in a world with very few good values.
Where are the new global opportunities?
29/06/2015  Global fund managers discuss emerging opportunities beyond the local market.
3 key risks for retirees
24/06/2015  Accurium SMSF technical services manager Melanie Dunn discusses three factors trustees should be aware of as they move from the accumulation to the retirement phase.