Idea of the Day: The Banks
It has been a torrid few days for the banks with ANZ cutting its franking from 100% to 70% and WBC cutting its dividend from 94c to 80c and raising $2.0 billion in an institutional share placement at 2532c with a share purchase plan to come. WBC has dropped 6.6% since the ANZ results and ANZ has dropped 7.3%. The NAB is down 4.6% in a week and the CBA 4.0%.
NAB results tomorrow – After announcing additional customer remediation charges in early October there have been a slew of broker downgrades already for the NAB so results tomorrow would have to be really bad to be bad. In October some brokers downgraded cash earnings numbers by 15-20% for charges relating to customer remediation. You would think that had cleared the decks but after the ANZ and WBC results it is clear that remediation costs are only one of their issues.
Some brokers have already highlighted the need for the NAB to raise their tier 1 capital ratio and after WBC opened the gates for a dividend cut and a capital raising this week the obvious concern is that the NAB will follow suit. They have the weakest tier 1 capital ratio of all the banks. By issuing shares they will dilute earnings. Downgrades will follow. The stage is set for them to raise capital, they would be foolish not to take the opportunity.
Here are the current broker recommendations for NAB most of which were downgraded after the October announcement about increased customer remediation charges:
Westpac – I heard one broker saying “fill yer boots” with WBC after the share price fall and the capital raising on Monday (maybe they were getting paid to put the capital raising away), but before you do that here are the broker comments on WBC after the capital raising and some collected comments from the research – I’m not sure anyone would be buying into this outlook:
- Revenue pressure is intensifying.
- Results were below expectations.
- Earnings downgraded by 5%.
- Earnings numbers reduced by 15%.
- Earnings forecasts reduced by 8%.
- Net profit forecasts cut by 8% for 2020 and 2021.
- Expect flat dividends.
- The bank faces a number of headwinds in 2020.
- Headwinds not limited to lower interest rates.
- Dividend and capital issues have now been dealt with and there is relative upside.
- Expect weaker volume growth, lower Wealth income and modestly higher costs in 2020.
- Low interest rates will weigh on profitability.
- Surprised by extent of margin impact from lower cash rates.
- Dividend was cut even further than the 84c expected.
- WBC now over-capitalised with a tier one capital ratio of 11.25%.
- WBC now our preferred bank.
- Results were broadly in line.
- Underlying trends are weak.
- Earnings expected to continue to decline in 2020 and 2021.
- Capital concerns have now being addressed.
- Outlook challenging with margins under pressure and limited balance-sheet growth.
Here are some collected ANZ broker comments after the results:
- Earnings forecast downgraded 8%.
- Material forecast downgrades caused by cost headwinds and reduced market income.
- Cut in franking to 70% a surprise.
- Franking will stay at this level for some time.
- Cash earnings forecasts cut by 12% for 2020 and 2021 on lower net interest margins and higher expenses.
- Earnings missed expectations.
- Underlying revenue pressures for the year ahead.
- Expect another drop in cash earnings in 2020.
- Earnings to fall 8% in 2020.
- Earnings to fall 10% pre-provisions in 2020.
- ANZ need to raise their capital level by around 4 billion over the medium term – (Suggests that ANZ will be kicking themselves that they have been beaten to the punch by WBC and didn’t also have a capital raising with the set of results).
- More capital may be required to meet as yet unknown RBNZ requirements.
- Uncertain whether they have taken sufficient remediation provisioning.
- Drivers for the outperformance of ANZ relative to the other banks have run their course.
- Ultra-low interest rates have forced ANZ to change tack to find growth.
- The stock is fair value.
- Results 3.5% short of expectations on net interest margin reduction.
- Management outlook is downbeat.
- Dividend stability is uncertain.
- The bank will face another difficult year with low interest rates impacting margins.
- Loan growth expected to be close to 0 with margins and fees under pressure.
- A dividend cut is likely in 2020.
- PE discount is justified versus other major banks.
Broker forecasts for the CBA haven’t changed since August but obviously there is now a risk that brokers will be downgrading target prices and recommendations in the wake of the other bank sector results and the messages they are passing about the need for more capital and the industry trends, in particular the drop in net interest margins which suggest that earnings will need to be downgraded for all the banks.
We’ll find out whether the NAB cuts its dividend and has a capital raising tomorrow but after Westpac has opened the door and remembering that after the CBA raised capital in 2015 all the other banks saw that as the excuse for them to follow suit, you have to assume that there is a high chance of NAB doing both. After which you might expect the ANZ and possibly the CBA to follow.
- WBC – Has cut its dividend and raised capital. It is now the best capitalised of the majors and has taken the pain. After the share price correction it is probably the best of a bad bunch.
- NAB – We will find out tomorrow but a dividend cuts and capital raising is now a possibility. The stock is only down 4% in the recent correction compared to ANZ and Westpac down 6% to 7%. Results are a risk.
- CBA – No results until February but if interest rates remain low and the housing market flat they may also have a capital raising and a cut dividend.
- ANZ – They have come franking but not the dividend and they have missed their opportunity to raise capital before the other banks. Probably the worst of a bad bunch.
If you are interested in growth there is nothing for you here at the moment. As you can see from the broker comments above the outlook for the sector if for earnings to fall next year and the next, further capital raisings are likely and dividend cuts are still on the cards from the NAB, CBa and possibly ANZ. You can look at the yield but ultimately it is the total return that matters. Even if the dividends are maintained, if the value of the industry, the intrinsic value of each stock, is tumbling, which it will if interest rates continue to trend to zero, you will lose more in the share price than you will make in income. A lot of income investors shut their eyes to the value of the shares, I don’t want to scare them, but your total return outlook is not good even if a bank does yield 7%. The one caveat to this is if the market’s central assumption, that interest rates are trending towards zero, is incorrect. If the comments from Jerome Powell last week (not expecting to cut rates again because the economy looks okay) and the small rise in bond yields recently is anything to go by, the zero bond yield fear may have peaked. If interest rates bottom we will all have to reassess our bank sector gloom.
Lessons: We are kicking ourselves for buying the banks ahead of results (obviously) but at the time, the sector was in uptrend and we felt the results risk had been significantly lessened by the pre-announced customer remediation costs which we thought had cleared the decks ahead of the results. Dividend cuts and capital raisings were not expected. In hindsight, as always, the safe approach if trying to strip a dividend out of an income stock is to wait until the results are out before buying for the dividend. It takes all the risk out of the dividend stripping.
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