Australian Banks – Last of the Golden Weather?
There has been much debate over the past 12-18 months over the Tasman regarding the outlook for the Australian banking oligopoly of ANZ, Commonwealth Bank of Australia (who owns ASB Bank in NZ), National Australia Bank (who owns BNZ), and Westpac.
The main issue has been the Australian regulators, namely the Australian Prudential Regulatory Authority (APRA), and the Reserve Bank here in New Zealand, requiring the major banks to hold significantly more tier 1 equity to cover their liabilities. This, in layman’s terms, means the banks have to have more equity to cover their lending. More equity means their earnings are spread over more shares, thus earnings per share, and presumably dividend’s per share will fall.
The comparison shown below with their international peers illustrates how high the payout ratios of the Australasian banks are:
With the regulators requiring the banks to hold increasing amounts of equity to safeguard against financial shocks, it is hard to see how these high payout ratios will be maintained.
Return on Equity Unsustainable?
The head of APRA, Wayne Byres, has specifically noted the major Australian banks have restored their returns to that prior of the Global Financial Crisis (GFC) which is in excess of 15% while the rest of the banking industry in Australia is earning a return closer to 10%. He said :
“While low relative to the major banks, this group of ADIs (Authorized Deposit-taking Institutions) is still earning a return that is commensurate with large US banks, and above that of large UK and European banks. Therefore, one of the more interesting questions that I think remains open to debate is where the ‘right’ RoE (return on equity) for a more resilient banking system is likely to settle.”
In our opinion, this is a clear sign the regulator can see the banks holding significantly more capital than they have now to make the banking system more resilient. This will have the effect of spreading the banks earnings over more equity and thus reducing their earnings per share. This in turn will reduce dividend payouts which is a major support for the banks’ share-price, in particularly from retail investors.
Bad Debt charges as good as it gets?
Bad debts are currently running at historic lows at around 0.15%, which is a 63% discount to the long term average. The graph below shows this clearly:
Thus a ‘normalization’ of bad debts to a long term average will impact the banks significantly as well.
The major Australian banks have no doubt been fantastic investments over the past 15 years. This has been due to a combination of dominant market position (essentially an oligopoly), leveraging up their balance sheets, historic low bad debt ratios, and extremely high dividend payments which have increased year after year.
However major structural shifts, in the shape of a much more rigorous regulatory environment, bad debt levels rising from historic lows, technological change, and increased competition and funding costs mean that we feel that their earnings and dividend growth may stall. This will be reflected in their return on earnings coming ‘back to the pack’ with a commensurate reduction in share prices. We recommend clients with significant or overweight share holdings in ANZ, CBA, NAB, and Westpac consult their advisor to see if their holding is appropriate for their portfolio.