Banking on the banks for higher capital returns
Although the latest coronavirus outbreak has given some reason for pause when considering when the nation will finally be through to the other side of the crisis, the response playbook has successfully been established with a mix of lockdowns and government support. We expect the latest restrictions to delay any taper from the RBA but a strong economic rebound to unfold post-lockdown once again and as the country moves closer to the necessary levels of vaccinations across the population. Hopefully this process will be accelerated.
Housing markets have continued to strengthen, with prices rising in all major markets, while housing credit growth has picked up (great for the banks), with strong demand from owner-occupiers, including first-time buyers. Investors are also increasing borrowing.
The RBA recently reaffirmed it is committed to supportive monetary conditions to return the market to full employment and doesn’t intend to lift the cash rate until actual inflation is “sustainably” within the 2-3% target range. The base scenario is this condition won’t be met before 2024 and even with the recent lockdowns we feel confident this timeline could prove unnecessarily pessimistic, given the strong V-shaped economic recovery we have seen and should see extended in upcoming quarters after a pause related to these lockdowns. A booming export sector is providing support and government stimulus playing a key role.
The sector has been rationalising its physical branch network, with people now used to doing most banking online and these cost savings are here to stay, offsetting pressure from complying with regulations. In addition, after a period of contracting net interest margins, these are set to expand again going forward and funding costs are dirt cheap.
Being on the cusp of a fresh reporting season, and with the banks having accumulated huge levels of excess capital and now having significant experience in understanding the outcomes from movement restrictions we believe they will begin to feel comfortable returning some of that to shareholders going forward through higher dividends and/or share buy-backs.
ANZ has kicked off the process on this front, announcing on 19 July plans to buy-back up to $1.5 billion of shares on-market. ANZ management seem confident the capital position is strong enough to provide flexibility for customer support and still return excess capital to shareholders, with the repurchase likely to begin in August.
ANZ CEO Shayne Elliott said, “After taking into consideration the ongoing pressures in some parts of the economy due to COVID, including the current lockdowns in parts of the country, the strength of our balance sheet and ongoing financial performance means we are in a position to return a modest amount of surplus capital to shareholders through a buy-back of shares on-market.”
He continued, “Just as we supported our customers through previous lockdowns we stand ready and able to provide assistance to those that need it. The strength of our business means we are well placed to fulfil needs of our customers and the broader community while still actively managing our capital.”
ANZ reported a Level 2 and Level 1 Common Equity Tier 1 capital (CET1) ratios of as at 31 March 2021 of 12.4% and 12.2% respectively. Both are far above APRA’s unquestionably strong capital requirement of 10.5%. The on-market buy-back is only expected to reduce March’s 2021 CET1 ratio by approximately 35 basis points.
At the time of ANZ’s first half results in March, ANZ had about $7 billion in excess capital, so the $1.5 billion buy-back could later be added under our base scenario for the economy and the banking industry, along with higher dividends. To recap, back in May, ANZ reported that cash profit from continuing operations more than doubled to $2.99 billion and was up 28% on the 2H20 figure. ANZ raised its interim dividend to a fully franked 70 cents per share, up 180% and exceeding market expectations for 63 cents.
Collectively, Australia’s big four banks are estimated to be holding roughly $34 billion in surplus capital. Bad debts across the industry have been much lower than anticipated and continue to be so both in mortgage and corporate markets. That ANZ was able to begin share buy-backs suggests regulators are okay with this to begin in modest amounts to begin with.
In the upcoming reporting season (August), CBA is the only big bank set to announce a full year result and we suspect it will join ANZ in returning some excess capital. When CBA provided its third quarter update in May, the CET1 ratio stood at 12.7%, up 10 basis points in the quarter after the payment of the 1H21 dividend. When CBA reported its 1H21 results earlier in the year, the CET1 ratio then had increased 100 basis points over the previous six months. Momentum in the third quarter showed robust continued lending and earnings growth, with some broker upgrades to follow. Cash NPAT of $2.4 billion was up 24% from the first half quarterly average, driven by lower loan impairment expenses and solid operational performance.
Expectations are relatively high for CBA, which trades at a premium to our preferred positions in the other big banks. Nonetheless, the strong capital position certainly provides the platform for it to release some surplus capital.
The reporting season in August will otherwise be quiet for the sector, with NAB to provide a relatively brief third quarter update, while Westpac and ANZ are only scheduled to issue Pillar 3 reports. Bank of Queensland full year results are a long way off, scheduled for October.
NAB recently estimated that after proceeds from the sale of the MLC Wealth business and other transactions, the pro forma CET1 as at 31 March was estimated at 12.68%. NAB though is working hard to address AUSTRAC concerns and will need to lift spending to accelerate its rectification of these issues. Management still has much work to do on the streamlining and digitization of the business in our view. Accordingly, we feel higher capital returns could be delivered in upcoming quarters but are likely to be announced later, perhaps at the full year results or perhaps after that when it has better addressed regulator concerns.
Westpac’s CET1 stood at 12.34% at the half year mark as at 31 March 2021 and since the sale of the non-core New Zealand life insurance business for NZ$400 million (A$373 million) has been announced, as Westpac continues to simplify its overall business. It is expected to result in a post-tax gain on sale and add approximately 7 basis points to Westpac’s CET1, although approval is not expected until later in the year. Bank of Queensland also had a strong CET1 of 10.03% at the end of its first half, which is more than adequate for a regional bank. However, we expect the focus for a while to be on the ME Bank integration, with the $1.325 billion transformational acquisition completed on 1 July 2021.
Managing Director and CEO Mr George Frazis said at the time, “Today is an exciting day for the BOQ Group and we are very pleased to welcome the ME Bank team to BOQ. The acquisition of ME Bank is strategically aligned and financially compelling. It further strengthens our multi-brand strategy, delivers material scale, provides portfolio diversification and enables the acceleration of the digital strategy towards a common digital Retail Bank technology platform.”
We have written in prior coverage of BOQ that we concurred with the positive view regarding the acquisition and that the price tag was very palatable.
Summary
There is abundant surplus capital in Australia’s banking sector, particularly for the big banks. Credit provisions write-backs are underway and bad debt formation remains low, while credit growth has been accelerating and earnings results seen so far in the sector have been strong, boding well for this to continue, even with some hiccups from the latest lockdowns.
The sector has been rationalising its physical branch network, with people now used to doing most banking online and these cost savings are here to stay, offsetting pressure from complying with regulations. In addition, after a period of contracting net interest margins, these are set to expand again going forward and funding costs are dirt cheap.
ANZ has started the ball rolling with share buy-backs. We expect more to follow and dividends to further rise towards past levels in the sector. There are still challenges with some uncertainty from the recent lockdowns, but the past experience market participants now have bodes well for the banks being confident enough to lift capital returns while still retaining the necessary flexibility to support customers.
We reiterate our positive ratings for the banks under our coverage with a buy on Westpac, National Australia Bank, ANZ and BOQ.
Disclosure: Interests associated with Fat Prophets hold shares in NAB, BOQ, ANZ and WBC.
