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How the banks dodged a covid catastrophe

Lex Hall  |  07 May 2021Text size  Decrease  Increase  |  
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Australia’s major banks may be fairly valued and carry high uncertainty ratings, according to Morningstar, but they’re in pretty good shape, considering the year they’ve had.

As one wag put it this week, it’s like covid never happened. The 2021 half-year results of the major lenders showed a 62 per cent increase in combined cash earnings from the same time last year, totalling $13.8 billion, according to a review by advisory Ernst & Young. Investors are cheering too as the dividend tap has been resolutely turned back on.

Westpac (ASX: WBC), Australia’s second largest lender, and the most preferred bank in Morningstar’s eyes, will pay an interim dividend of 58 cents a share after scrapping payouts amid economic uncertainty a year ago. It had paid a modest 31 cents in the second half of the last financial year.

ANZ (ASX: ANZ), which had also scrapped an interim dividend last year, also declared a better-than-expected first-half dividend of 70 cents a share.

Not to be outdone, NAB (ASX: NAB) will pay a first-half dividend of 60 cents a share, double the amount it paid for the same period last year, when it was forced to slash the payout.

Commonwealth Bank (ASX: CBA) has a trading update next week, and investors can expect the outlook to remain positive, says Morningstar banking analyst Nathan Zaia.

“Despite potential cyclicality, the outlook for dividends is positive,” Zaia said in a note this week. “The major banks trade on fully franked FY21 dividend yields above 4.0 per cent, and we expect growth of around 7.5 per cent a year from 2021.

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“Capital management initiatives such as buybacks or special dividends are likely.”

It’s a far cry from last year when profits plunged as the pandemic forced banks to put more money aside for potential defaults and other future liabilities—an insurance measure known as a provision.

But the rain never became a full storm front because of several key factors, including the temporary deferral of loans, a deluge of government stimulus money, and a surge in people putting their money in the bank rather than taking it out.

Fifteen months from when the covid-19 was first declared a pandemic, the Australian economy is rebounding. Unemployment is falling, business activity is stirring, and consumer sentiment is at its strongest level in more than a decade. Consequently, consumer spending is expected to be a major driver of growth due to record low interest rates, and rising house prices.

For banks, the historically low cash rate of 0.10 per cent has crimped margins. But Zaia expects this to reverse in line with RBA’s talk of rate rises from 2024.

“Over the next three years we expect net interest margins (NIM) to trend lower as the headwinds from low interest rates fully play out,” Zaia says.

“We expect a recovery to start from 2024 as the cash rate increases and pressure on NIM abates.”

But investors should avoid paying too much attention to the timing of a rate rise, Zaia says, because it is immaterial to his valuations.

“What is important is that the trajectory changes, and we are confident this will come given the cash rate and mortgage rate are at historic lows.”

Australia’s wide moat lenders

A table showing valuations for Australia's wide-moat big four banks

Source: Morningstar Direct; data as of 6 May 2021

Key takeaways from Zaia’s outlook include:

  • Bank margins are likely to fall up to 10 basis points in the medium term.
  • Scope for the majors to increase the price of loans to preserve margins.
  • Home loan growth to average 3.5 to 4 per cent for the five years to 2025.

As the for valuations, Westpac is the cheapest, Zaia says. “But Commonwealth Bank has the greatest upside to rising rates given a larger customer deposit funding base, which won’t reprice as quickly or to the same extent as funding costs.

“ANZ’s large institutional banking business would likely be worse off if rates remain at current lows. Our ANZ fair value estimate falls 19 per cent if the longer-term NIM stays around 1.5 per cent, in line with our fiscal forecast.”

Solid economy boosts profits for majors

Westpac, Australia's second-largest lender, on Monday reported first-half cash earnings, which strip out items like hedging impacts and one-off events, more than trebled to $3.5 billion after it wound back some provisions to cover potential loan losses.

Statutory net profit for the six months to 31 March was 189 per cent higher at $3.4 billion, a respite from the challenging period in 2020 because of covid.

Westpac said lending for housing had surged and its Australian mortgage book expanded by $2.6 billion in the six-month period, even though growth in owner-occupier loans was partly offset by lower lending to investors.

Westpac shares jumped on the news, hitting a fresh 52-week high. It closed on Thursday at $26.02, against Zaia’s fair value estimate of $29.

ANZ more than doubles first-half cash profit

ANZ posted a sharp rebound in first-half profit, as improving economic conditions helped it increase market share in the home loans segment and wind back some provisions for potential covid losses.

It reported cash profit for the six months to 31 March more than doubled from a year ago to $2.99 billion.

Statutory net profit also jumped, nearly doubling from a year ago to $2.94 billion as the bank wound back almost $500 million in provisions due to improving credit conditions.

ANZ is now the third largest home lender in the Australian market, after writing 92,000 new home loans during the six-month period. It is already the leading lender in the New Zealand property market, with 42,000 new loans there.

It closed on Thursday at $27.65, against Zaia’s fair value estimate of $29.

NAB lifts first-half profit

NAB, Australia's third-largest lender, also staged a strong rebound, posting a 94 per cent jump in first-half cash earnings to $3.3 billion.

NAB's operating revenue for the half-year dipped 1.5 per cent to $8.26 billion, although statutory net profit for the six months to March 31 more than doubled to $3.2 billion.

A resurgent housing market allowed the lender to write back provisions of $128 million in the first half, compared with a $1.2 billion charge a year ago.

Cash earnings at its key business banking segment were down 10.3 per cent from a year ago to $1.2 billion.

NAB said about $2 billion, or 9 per cent of the amount originally deferred, was being managed by a special workout team but only $200 million of this has been due over 90 days.

By contrast, NAB's personal banking unit saw cash earnings rise 14.1 per cent from a year ago to $859 million due to reduced credit impairment charges and low funding costs.

On Thursday, NAB closed at $26.56, against Zaia’s fair value estimate of $26.00.

Commonwealth Bank will post a third-quarter trading update next week. It closed on Thursday up 0.24 per cent to $92.94, against a Morningstar fair value estimate of $77.00.

is senior editor for Morningstar Australia

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