Bank CEOs have an interest in making “glass half-full” public comments, but they too have been noticeably upbeat. ANZ Bank chief Shayne Elliott even flirted with the idea Australia was in economic boom territory.
“GDP’s really strong, unemployment’s falling, house prices are up. It’s probably – I don’t know if you’d use the boom word, but you wouldn’t be far away,” Elliott said this week.
Investors are similarly bullish. While bank shares didn’t shoot the lights out this week, NAB, ANZ and Westpac have rallied about 75 per cent from their 2020 lows, and CBA is up about 60 per cent.
For shareholders who wore savage dividend cuts last year, the sudden turnaround in banks’ fortunes may come as a surprise. Though at the same time as bankers delivered their profits, they also emphasised the economy’s recovery was uncertain and urged the government to continue playing a highly supportive role through next week’s budget.
So if the economy is not entirely out of the woods, why have bank profits bounced so strongly? And will the recovery in profits and dividends last?
The turnaround in banks’ headline profits this week, while massive, does overstate the underlying improvement in these businesses. That is mainly because this year’s earnings are being compared with depressed levels of last year, when bad debt provisions took a bite of almost $5 billion out of the big four’s profits.
GDP’s really strong, unemployment’s falling, house prices are up. It’s probably – I don’t know if you’d use the boom word, but you wouldn’t be far away
ANZ chief Shayne Elliott
At the time the dominant view among experienced bank-watchers was there was more pain to come, as hundreds of thousands of small business loans and mortgages were put into emergency deferral.
Yet the much-feared wave of bad debts has not arrived. So, banks have begun cutting these provisions by hundreds of millions of dollars, leading to a powerful rebound in the bottom line.
Principal at fund manager Alphinity, Andrew Martin, says given the size of the provisions taken last year, the benefits of falling bad debts will probably keep on supporting banks’ earnings as the economic recovery gains momentum. “It’s going to be beneficial for some time, I would have thought,” he says.
If provisions are excluded, the banks’ profit bounce-back is less dramatic. KPMG says that if COVID-19 related charges and this year’s unwinding of the provisions are stripped out, the banks’ net pre-tax profits rose by a far more modest 1.3 per cent.
Even so, bank profits are also enjoying a range of other “tailwinds” that are prompting brokers to lift their earnings estimates. These include faster loan growth, a cost-cutting drive, and wider net interest margins, which compare funding costs with what they charge for loans.
While falling interest rates have been squeezing margins for years, Xiradis points out rates probably can’t go much lower and the next move in rates is likely to be an increase. “That headwind as far as interest rates are concerned in the future could turn into a tailwind,” he says.
Jefferies analyst Brian Johnson also cites an eventual rise in interest rates as one reason why he thinks banks will outperform other parts of the sharemarket. “I think the rotation into banks continues apace,” Johnson says.
The housing boom is a further benefit, underlined by Westpac this week lifting its forecast for housing credit growth to 6.5 per cent for the year, up from 4.1 per cent today. Chief executive Peter King said house price rises were being driven by “classic supply and demand,” and the growth will eventually slow.
“It’s more a short-term cyclical thing that’s going on, and affordability will eventually bite, but it doesn’t feel like it’s going to run out of steam straight away,” he said this week.
Westpac is betting on a 20 per cent rise in house prices over 2021 and 2022, compared with this time last year, when its “base case” was a 15 per cent drop in house price in 2020 and a further 5 per cent decline in 2021.
Another cause for excitement in the markets is that banks are sitting on billions of dollars in surplus capital, thanks to asset sales and moves to retain earnings for a rainy day that didn’t arrive. ANZ’s Elliott called its stockpile of excess capital “an embarrassment of riches”. Xiradis says the excess capital was the standout feature of these results and he thinks share buybacks from the banks are “very likely”.
There are still risks, including how the economic recovery will fare as the government scales back support, and the risk of COVID-19 outbreaks and lockdowns is ever-present.
Yet so far, banks’ profit-making engines have largely been protected by Australia’s management of the pandemic, which owes much to state and federal government actions. Whether through the $90 billion JobKeeper scheme, or a Reserve Bank program to provide up to $200 billion in ultra-cheap loans to banks, the benefits to banks of public support have been considerable.
As Jefferies’ Johnson puts it: “There would have been a loan cycle, but it’s just been transferred to the taxpayer.”
Despite the market euphoria towards banks, however, it has not been a complete snap-back. Dividends are still significantly below pre-COVID levels, and boards have lowered the proportion of profit paid to shareholders.
Westpac, for example, this week said a sustainable dividend payout ratio would be between 60 and 65 per cent of profits, compared with 83 per cent between 2017 and 2019.
However, market observers are not overly concerned because they say payout ratios were previously too high.
Tribeca Investment Partners portfolio manager Jun Bei Liu says she expects big rises in the absolute value of bank dividends as the sector continues to benefit from economic improvement and the housing boom. “Dividend growth should be enormous out of the banking sector over the next 12 months,” she says.
After the panic of last year, it has certainly been a wild rise for bank investors, who have seen the value of their shares surge dramatically from last year’s lows.
There is also a clear sense of relief among bankers at what has been avoided.
When NAB’s McEwan looked back this week on how events had transpired over the past year, he remarked at how quickly the economy had rebounded, thanks in a large part to the actions of government and the general public. Sure, it has not been the disaster banks planned for. But that’s a pretty good problem to have.
“At the time I said we wanted to be a very safe bank, that’s the positioning I took. If I got it wrong, well I’m happy to be in a very strong position now going forward for customers and our shareholders,” McEwan said.
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