Stock Review

Big banks & the Basel hoax Pt 1

8/11/2011

  • Category: BLUE CHIP INDUSTRIAL
Company Price at review Current price Fundamental risk Share risk Our view
ANZ Bank (ANZ) $21.19 $30.13 2 3 Hold
NAB (NAB) $25.18 $32.47 2 3 Avoid
Westpac Bank (WBC) $21.11 $32.95 2 3 Hold

Three of the big four banks have announced their full year results. Nathan Bell analyses what they mean and, tomorrow, explains the ‘tight regulation’ ruse.

At the recent Commonwealth Business Forum, Australia’s richest person, iron ore magnate and champion of the working family, Gina Rinehart, warned that we should not be ‘mesmerised by our good fortune’ as ‘regrettably [it] will not last’.

That Australia’s big four banks trade on such a high average fully franked yield of 6.8% suggests the market concurs with her.

Though Rinehart was referring to the resources boom, so it goes with the banks.

How long might it be before the earnings of Australia’s big banks succumb to falling credit growth, new regulations to curb lending and profitability, China’s attempts to orchestrate a soft economic landing and another global credit freeze?

Key Points

  • Banks remain highly profitable

  • Dividends are rising and bad debt are falling

  • Retaining a 10% portfolio limit and no sector buys as yet

Before examining this biggest of big banking issues, let’s first look at the latest round of annual results. They offer no clues about the possible chaos of what might lie ahead, which is why we’ll spend some time tomorrow fleshing out the issue everyone would rather ignore.

National Australia Bank

Whilst National Australia Bank’s operating income increased 6% to $17.6bn, it was flat in the second half compared with the first, reflecting sluggish credit growth.

Underlying profit before bad and doubtful debts increased 10% to $9.6bn (again, all the growth was in the first half), but thanks to a 20% drop in bad debts to $1.8bn, cash earnings increased 19% to $5.5bn.

At 15.2%, return on equity was lower than that of its rivals but still respectable. Cash earnings per share increased 16% to $2.47 and a final fully franked dividend of 88 cents was declared (ex date 10 Nov), up from 78 cents. That brings the annual total to $1.72 and a yield of 6.8%.

National Australia Bank’s aggressive advertising and price competitiveness helped its mortgage book grow three times faster than overall home lending, although its recent decision not to pass on the full 0.25% fall in the official interest rate may yet tarnish its brand.

Management’s strategy of abolishing certain fees and lowering borrowing rates has thus far been a success but with offshore borrowing becoming more expensive, the bank must be careful. The temptation will be to increase short-term profits at the expense of its financial position.

With the share price up 12% since 22 Aug 11 (Hold – $22.45), we’re switching to AVOID.

Westpac Bank

Westpac’s profit before tax and impairment charges was flat at $9.5bn with operating income up just 1% and expenses up 2%. But a 32% fall in bad debts to $993m produced a 7% increase in cash earnings to $6.3bn and a 6% increase in cash earnings per share to $2.09.

A fully franked dividend of 80 cents was declared, up 8% (ex date 7 Nov), bringing the full year total to $1.56. That puts Westpac on a fully franked yield of 7.4%.

The bank’s net interest margin—the difference between the rate it charges on loans and what it pays on deposits—held steady at 2.22%, producing a return on equity of 16%. That’s well below the 20.9% achieved in 2007 but an increase on the 10.3% in 2009.

Of the 4%, or $19bn, increase in lending, $17bn related to mortgages. Australians are as keen as ever to sink more debt into housing, despite price falls. To preserve margins staff numbers are being cut with some tasks being shifted overseas.

Despite customer deposits now funding 63% of customer loans, as with its rivals Westpac’s reliance on short-term wholesale funding remains an Achilles heel. But meeting higher capital requirements in 2013 shouldn’t be an issue, assuming the economy doesn’t leap off a cliff.

The share price has increased 2% since 17 Aug 11 (Hold – $20.77) and we’re maintaining our HOLD recommendation.

Note: The model Income portfolio owns Westpac shares.

ANZ Bank

ANZ’s profit before tax and impairment charges increased 6% to $8.9bn year on year, with operating income increasing 8% to $16.9bn.

With chief executive Mike Smith ordering his traders to exit their positions, operating income fell 3% to $8.3bn in the second half whilst a 31% drop in bad debt provisions to $1.2bn helped produce a 19% increase in net profit.

Earnings per share increased 10% to $2.18 and a final 76 cent fully franked dividend was declared, up from 74 cents (ex date 10 Nov). That brought the annual total to $1.40, putting ANZ on a 6.6% yield.

Smith is poised to pounce as European banks are forced to sell Asian assets, creating opportunities for it to reach its goal of earning 25% to 30% of net profit from Asia by 2017.

Unwilling to weaken ANZ’s financial position, Smith intends to raise fresh capital for the right opportunity. Like his contemporaries, he expects ANZ will be paying 30 to 50 more basis points for overseas wholesale funding next year and he expects the economy to slow.

ANZ’s Asian growth strategy may turn out to be perfectly timed, but given the myriad risks of international acquisitions we’re prepared to wait for a larger margin of safety.

The share price has increased 10% since 22 Aug 11 (Hold – $19.34) and we’re sticking with HOLD.

The good news for Australia’s major banks is self-evident. All are highly profitable, dividends are growing and bad debts are falling. Not much to worry about there.

The reasons why we recommend you keep the banks to less than 10% of your portfolio will be explained in part 2 of Big banks & the Basel hoax tomorrow, but there’s a rather large clue in the title.

Disclosure: Staff own shares in Westpac and Commonwealth Bank, but not the author, Nathan Bell.


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