Last week, the Commonwealth Bank of Australia surprised the market with a further $714 million in new customer compensation costs – taking its bill so far to $2.17 billion. National Australia Bank said its first-half earnings would be reduced by $749 million, due to growing customer remediation costs. ANZ has announced remediation costs of $907 million. Westpac copped a $510 million pre-tax provision for the same purpose.
The banks have flagged that compensation bills could rise even higher.
The problem for bank investors is that this justified reckoning for the industry’s misconduct is coming at a time when revenue growth is almost non-existent, in the face of a housing market downturn. Cutting costs is about the only way at present for banks to show earnings growth.
The perfect storm for the banks has begun to show up in dividend cuts – once considered by investors as unthinkable. National Australia Bank bowed to the inevitable and lowered its interim dividend from 99 cents to 83 cents, its first dividend cut in five years. ANZ, CBA and Westpac all managed to keep interim dividends where they were, but analysts believe Westpac’s dividend looks shaky.
For the share market investors that flock to the banks’ shares for income, the Royal Commission-inspired plunge in the major banks’ share prices exposed them to the capital risk of seeking income from shares: the banks’ share price falls ranged from 15.1% for CBA, through 23.9% for ANZ, 25.2% for Westpac, to 30.3% for NAB. This may well have been only a paper loss from peak capital gain for investors who had owned the shares for many years, but for more recent buyers, it could have been very painful.
However, share price falls can effectively increase the expected dividend – provided, of course, that the dividend can be maintained.
With the risk of the Labor Party’s policy to remove franking credit rebates for investors on 15% and zero tax rates removed by Saturday’s election outcome, the ability of fully franked bank dividends to generate income for investors is safe as a cornerstone of income-oriented portfolios. But investors following this policy do need to keep an eye on the bank earnings that fund these dividends.
Here’s my take on the Big 4 banks:
1. ANZ (ANZ, $27.77)
Market capitalisation: $72.2 billion
FY20 Forecast yield: 5.9%, fully franked
FY20 Forecast grossed-up yield: 8.4%
Analysts’ consensus target price: $28.81 (Thomson Reuters), $27.76 (FN Arena)
Despite the difficult operating environment, ANZ reported a 2% rise in cash profit – the bank’s preferred measure, which strips out one-off gains and losses – to $3.5 billion, which beat analysts’ expectations. Revenue fell by 1% to $9.7 billion, but that was more than offset by cost cuts. Net profit was 5% lower, at $3.17 billion.
While the bank’s remediation costs are lurid, approaching $1 billion, the dividend was maintained at 80 cents, and ANZ managed to strengthen its capital buffer, and bad debts fell. ANZ was actually the first bank to report a fall in housing credit (down 1%), but it grew business lending by 11%, about double the average growth rate of its peers.
Consensus forecasts project that ANZ can maintain its dividend, provided it lowers its payout ratio. After paying $1.60 a share for the full-year FY18, FN Arena’s consensus collation shows ANZ paying 160.3 cents in FY19 (year to end-September) and 163.3 cents in FY20. Thomson Reuters expects 160 cents in FY19 and 164 cents in FY20. If these expectations are met, ANZ is priced as offering an 8.4% grossed-up yield – but analysts see the share price as getting close to full value.
2. CBA (CBA, $77.55)
Market capitalisation: $128.8 billion
FY20 Forecast yield: 5.6%, fully franked
FY20 Forecast grossed-up yield: 7.9%
Analysts’ consensus target price: $72 (Thomson Reuters), $69.58 (FN Arena)
Being a June 30 balance-date company, CBA was out earlier with its half-year profit – in February – when it reported a 6% fall in its net profit, hit by the costs associated with fixing historic misconduct issues and tighter margins due to competition and rising costs. First-half net profit came in at $4.6 billion, down from $4.9 billion in the corresponding period in 2017, while cash profit was 1.7% higher, at $4.68 billion. CBA maintained its interim dividend, at $2 a share.
Since its interim result, CBA has surprised the market with a poor third quarter, with the additional $714 million provision for customer compensation dragging cash profit to $1.7 billion – a 28% slump compared to the average of the first two quarters of the financial year.
Analysts already expected CBA’s earnings per share (EPS) to fall in FY19, by about 9%, before posting a 5% rise in FY20. While there may be further markdowns to estimates on the back of the third-quarter update, there could be enough earnings fall factored in.
CBA did manage to lift the number of home loans written by 2.5% in the March quarter, which would have comforted analysts that it is defending its status as market leader. The volume of new business loans also increased, by 2.3%.
At the current share price, CBA is projected to pay a 7.9% grossed-up yield – but analysts are concerned that its share price outlook is weak.
3. National Australia Bank (NAB, $23.94)
Market capitalisation: $67.1 billion
FY20 Forecast yield: 6.9%, fully franked
FY20 Forecast grossed-up yield: 9.9%
Analysts’ consensus target price: $27.26 (Thomson Reuters), $26.60 (FN Arena)
NAB did bite the bullet on its interim dividend, lowering it by 16% to 83 cents. While a cut was expected, the actual fall was larger than analysts expected. Net profit for the half-year to March was up 4.3% to $2.7 billion, and cash profit growth was even higher, at 7.1%, to $2.95 billion. But with NAB’s payout ratio having been running at close to 100% of its earnings, something had to give, and that was the dividend.
NAB’s revenue rose by 1.4%, but its costs increased by 1.7%. The bank’s asset quality deteriorated markedly, with impairment charges spiking more than 20% to $449 million. Not only are home lending arrears rising, NAB also reported a small number of big business loans going sour.
On the positive side, NAB was able to report home loan growth in Australia. While it was only 2%, it was better than the 1% decline reported by ANZ.
Analysts expect NAB’s EPS to fall by about 3% for the full-year (year to end-September), before rebounding in FY20 – at this stage, the analysts’ consensus projects higher EPS in FY20 than in FY18. The dividend, however, is clearly under significant pressure: FN Arena’s collation predicts $1.66 for FY19, down from $1.98 in FY18, and a still-pressured $1.648 in FY20. Thomson Reuters projects a $1.66 full-year dividend in both FY19 and FY20.
On that basis, NAB is projected at the current price as paying a 6.9% yield in FY20, equivalent to a grossed-up yield of 9.9% – well above the market’s average grossed-up yield of just under 6%.
On share price grounds, analysts see NAB as having the best upside of the Big 4.
4. Westpac (WBC, $27.31)
Market capitalisation: $87.6 billion
FY20 Forecast yield: 6.9%, fully franked
FY20 Forecast grossed-up yield: 9.8%
Analysts’ consensus target price: $27.20 (Thomson Reuters), $26.92 (FN Arena)
Westpac’s first-half result (half-year to end-March) was a shocker in terms of the numbers, featuring a 22% plunge in cash earnings to $3.3 billion, as compensation and restructuring costs piled up against the backdrop of weaker house prices and a slowing economy. The bank made $1.4 billion in pre-tax provisions for customer compensation work over the past three years, with $1.2 billion poised to go directly in the hands of customers. Provisions slashed $617 million from first-half profit.
Net operating income fell 10%, to $9.98 billion, and net profit was down 24%, to $3.17 billion. Westpac’s net interest margin – the difference between the rate at which it borrows and the rate at which it lends – was 4 basis points lower to 2.12%, from 2.16%.
The bank maintained its first-half dividend at 94 cents, but some analysts think it’s going to be under pressure from here. On consensus grounds, FN Arena expects $1.88 a share in FY19 and FY20 – the same as FY17 and FY18 – and Thomson Reuters’ estimates collation agrees with that. But with revenue and earnings under pressure, UBS analyst Jonathan Mott has predicted that Westpac is likely to cut its dividend at the full-year – for the first time since the global financial crisis. Both UBS and Deutsche Bank rate WBC a “sell.”
If Westpac can maintain a full-year dividend of $1.88 in FY19 and FY20, the stock is priced on a 6.9% yield, equivalent to a grossed-up yield of 9.8%. But after Monday’s post-election surge, analysts don’t see much further room for share price growth.
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