Shareholders looking for regular income from dividends are wondering whether they should finally call time on what has been an anxious few years.
The coronavirus has delivered an unprecedented challenge for the banks, with share prices plummeting, huge provisions set aside to deal with bad loans and dividends firmly on the chopping block.
This comes after a tough few years for bank investors. The emergence of big foreign players in the mortgage market, a bruising royal commission, a sharp housing downturn and record low interest rates have taken their toll on banks, with share prices largely going nowhere in the last four years.
Investors had weathered dividend cuts, leadership changes, asset sales and restructuring but all that finally looked to be in the rear vision mirror as 2020 approached.
Commonwealth Bank of Australia delivered its first “clean” result for years in February, with no new remuneration payments to wronged customers, giving investors hope the others would be able to follow suit soon, with the worst seemingly in the past for the big four.
Now investors looking for regular income from dividends are wondering whether they should finally call time on what has been an anxious few years.
NAB surprised the market this week by announcing a 30¢ interim dividend. Most had expected the bank would defer it. That NAB paid out $900 million to shareholders while simultaneously asking them for $3.5 billion back shows the pressure it’s under to return capital to investors – even if many elect to give that money straight back.
While it shows the bank is intent on maintaining a dividend for the foreseeable future, it’s unlikely to be as high as it once was. UBS expects NAB’s dividend will remain at 30¢ per half year until the 2022 financial year.
ANZ this week deferred a decision on its dividend, saying it would wait until later in the year when there was more certainty on the economic fallout from the COVID-19 pandemic.
But that hasn’t delivered certainty for its investors, who will be unsure whether to ride out the economic cycle (in the hope of a dividend on the other end) or simply cut their losses and sell out now.
Westpac will face a similar decision when it reports next week. UBS expects the bank will defer a decision on its dividend, rather than pay the 20¢ it was likely to muster with its 75-80 per cent payout ratio.
Bell Potter is more bullish, forecasting Westpac could announce a dividend as high as 34¢. But others are more cautious. “If anyone’s buying the banks for dividends, I don’t know if that’s a safe bet at the moment,” says Aberdeen Standard Investment investment manager Jason Kururangi.
“I’d expect further deferrals or reductions and ultimately lower payout ratios.”
Commonwealth Bank was able to hold its dividend at $2.00 a share, fully franked, although that was in early February, well before COVID-19 became a major concern for the domestic economy.
It will also have the benefit of four months’ additional hindsight, with a decision on its next dividend set to come in August.
There’s no doubt at a price level that the banks look historically cheap. In fact, if you participate in NAB’s capital raising, you’ll be able to pick shares up at their cheapest price since 1997.
While that may seem justified given the economic environment, according to Bloomberg not a single broker has a sell rating on the stock, implying it looks pretty good value.
Goldman Sachs analyst Andrew Lyons, who has a buy rating on NAB, says it appears to be in a strong position to weather economic fallout from COVID-19.
“[The] first-half result showed that NAB’s ability to manage the trade-off between margins and volumes has improved considerably in recent years, and bodes well for the elevated commercial lending drawdown likely to take place as corporates respond to COVID-19,” says Lyons.
“Further, NAB’s cost performance in recent years, despite growing regulatory pressures, highlights discipline that should position the company well for the still tough revenue and asset quality environment.”
The same probably can’t be said for CBA. The stock has as many brokers recommending dumping it as buying it.
ANZ is trading at its lowest level since the global financial crisis (GFC), although most analysts say the stock is undervalued.
Westpac is also trading at its lowest level since the GFC, with the majority of analysts citing the stock as trading near fair value.
“We are seeing value and we have been buying the banks,” says Milford Asset Management portfolio manager William Curtayne.
“We think that once we get through this crisis, they’ll be paying 10 per cent dividend yield. The virus is getting under control, the economy will reopen and, for the next little while with some businesses getting back to work, there’s a fairly favourable outlook.”
Other fund managers agree. “The Aussie banks were trading around GFC lows [a month ago] whereas the rest of the market hadn’t got there yet,” says Wilson Asset Management lead portfolio manager Matthew Haupt.
“I still think they’re too cheap if we get a progressive roll out of the economy opening up and there’s a lot of bad stuff happening, but the pricing and valuation were too cheap relative to the rest of the market.”
There’s no doubt management is more certain for some banks than for others.
ANZ chief executive Shayne Elliott has been at the helm of the bank since January 2016 and has had to weather a bruising royal commission and now the most unprecedented economic crisis in Australia’s history.
The consistency of leadership has been of benefit to the smaller of the big four, with its shares outperforming Westpac and NAB over the last few years.
Since January 2016 – when Elliott took charge – to February 21 this year, just before the market collapse, ANZ’s shares fell 2.5 per cent.
NAB’s fell 5.9 per cent over the same period, while Westpac fell 23.1 per cent.
CBA rose 3.8 per cent, even with the chief executive role changing hands in early 2018.
Meanwhile, NAB and Westpac investors will have to back chief executives who have six months experience in the top job combined.
For Westpac investors, there will be some reassurance. Chief executive Peter King has been at the bank for 25 years and was the chief financial officer under Brian Hartzer.
That does mean, however, that management is unlikely to be materially different. Some shareholders may have reservations about this, given the recent money-laundering and child-exploitation funding scandal that led to the resignation of Hartzer and chairman Lindsay Maxsted.
NAB’s Ross McEwan has form in making the most of a bad situation. He turned the Royal Bank of Scotland from a basket case to a bank on track to average earnings per share growth of 10-14 per cent over the next three years.
“We and the market have a very strong view on Ross McEwan,” says Milford’s Curtayne. “A new CEO is actually a real positive for them.”
Neither King nor McEwan have unveiled any drastic plans to overhaul the bank. And until COVID-19 is in the rear-vision mirror, it’s unlikely much will change.
In terms of how exposed each of the banks are to COVID-19, Westpac, ANZ and NAB have already given investors a strong indication.
Last week, analysts and fund managers were saying the true impact of COVID-19 on the banks would be anyone’s guess given the unprecedented scale of the economic disruption. But the provision announcements from the major banks this week have given the market a firmer indication.
NAB announced it was setting aside an additional $800 million which some analysts noted was on the light side.
“While these scenarios were created bottom-up, we believe they may risk losing context. This $807 million overlay implies an 87 per cent chance of a rapid V-shaped economic bounce back, and 13 per cent chance of a traditional recession, rather than a U- or L-shaped pandemic,” says UBS analyst Jonathan Mott.
“This implies that if the economic downturn is more severe or the recovery not as rapid as NAB assumes, further top-ups will be required.”
NAB holds a large portion of the business lending market, however, which could help prop up its loan book through the downturn.
Business credit growth jumped 2.9 per cent in March, the biggest single monthly growth since January 1988, showing businesses are hungry for loans.
NAB is forecasting business credit will increase by over 16 per cent in the financial year to September.
Westpac said it would set aside a further $2.2 billion in loan provisions, with $1.6 billion directly related to COVID-19.
“We view the $2.2 billion impairment charge incorporating a $1.6 billion COVID provision as being more realistic and therefore lowering the risk of further significant reserve build at later dates, but this is caveated on understanding the detail of the scenario to be released at its result,” says Credit Suisse analyst Jarrod Martin.
ANZ announced it was setting aside $1 billion to cover the impact of the coronavirus – noteworthy because it is smaller than NAB in terms of market capitalisation.
Commonwealth Bank has been more tight-lipped but there’s no doubt its loan book means it could need to set aside more collective provisions than the other four.
The bank has about 25 per cent of the Australian home loan market and more than 16 per cent of the business lending market, according to APRA.
It’s due to provide a trading update to the market on May 13 and could choose then to announce its collection provision top up.
Bell Potter analyst TS Lim forecasts CBA’s impairment charge will be $2.05 billion in the second half of 2020, increasing to $3.12 billion in 2021.
Outlook for housing market
As one banking analyst once put it, mortgages are the perfect product for banks. They get a guaranteed customer for 30 years, consistent income and an asset to sell if the customer defaults.
But mortgage applications are likely to dry up in the coming months, with a lack of demand set to hit home values by 20 per cent.
Monthly and annual housing credit was stagnant in March despite ultra-low interest rates with investors in particular staying away from the housing market.
“Roughly speaking, the monthly amount of new lending to investors is falling just short of the repayment of debt made by investors and so the stock is falling a little each month,” says CBA senior economist Belinda Allen.
“We would expect this to continue as the housing market deteriorates over coming months.”
ANZ says it’s in a better position than its competitors to weather a housing market downturn because of its conservative home loan book.
The bank says it didn’t take on residential investor loans in the past year, meaning it’s less exposed to investor loans going bad if tenants are unable to pay rent.
“If residential housing begins to fall, there’s further downside there and then there’s not such good value in the banks,” says Milford’s Curtayne.
“CBA and Westpac have more residential loans on their books so they’ll be more vulnerable.”
At the end of the day, though, all the banks’ fortunes will be dependent on the housing market and a boom is unlikely.
“I think the banks are doing the best they can but it’s an exceptionally uncertain time,” says Aberdeen’s Kururangi
“Inherently, the banks are very cyclical and leveraged to the economy overall and if there’s one thing we know, the economy is going through a tough time.”
By William McInnes