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Can the banks get back to $25? That was the question Peter Switzer put to me at our regular Boom, Doom and Zoom webinar last Thursday. I was a little dismissive at the time because the first hurdle for ANZ, NAB and Westpac is to get through $20 (a level they touched briefly in June before rapidly falling away). But it got me thinking and is pertinent right now because we are coming into bank reporting season.
Over the next two and a bit weeks, each of the major banks will update the market on their earnings. ANZ will open the batting this Thursday with its full year results, followed by Westpac next Monday and then NAB on Thursday 5 November. CommBank will provide a first quarter trading update on Wednesday 11 November (it has a balance date of 30 June, whereas the other three majors rule off their books on 30 September). Bendigo holds its AGM on Tuesday, while Macquarie presents its first half results on Friday week.
Starting 2020 around $25, the major banks peaked in mid-February. When the S&P/ASX 200 peaked on 20 February at 7,162.5, ANZ closed at $27.03, NAB was at $27.40 and Westpac was at $25.69. Last Friday, with the ASX still down 13.9% from its peak at 6,167, ANZ had lost 26.8% to $19.78, NAB 28.7% to $19.53 and Westpac 26.9% to $18.78. However, this is a big improvement from the lows during in the pandemic rout (each down by more than 50%), and follows a strong outperformance in October where they have rallied by more than 10%.
So, can they sustain the momentum, crack through $20 and head back in time up to $25? Here are my thoughts. Let’s start with the tailwinds, and then the headwinds.
Responsible lending: Potentially, the Government’s move to unshackle the Banks from their ‘responsible lending’ obligations is a huge win. Credit growth has been anaemic in part because the responsible lending obligations render many personal and small business borrowers ineligible for a loan, or greatly reduce the amount they can borrow. Legislation won’t be debated in the Parliament until the Autumn session next year, and it is unclear whether the ALP or independents will support these changes, so this will have no impact on current year profits. However, it should be a tailwind for 21/22 and further out.
Covid-19 overprovisioning: Another tailwind for 21/22 is (what looks to be) over-provisioning by the banks for Covid-19 related losses. Earlier this year, each of the Banks booked material provisions to cover expected losses. These were based on scenario analysis, and assumed a contraction in economic growth, rising unemployment and a fall in house prices. Westpac, for example, had a base scenario of unemployment hitting 8.0%, house prices declining by 10% and the economy contracting by 4.0% this year before increasing by 3% next year. Commonwealth Bank had unemployment peaking at 9%, house prices falling by 12% and a 6% contraction in economic growth. Based on recent data, these scenarios are too pessimistic. Now it is unlikely that there will be any writeback of these provisions yet as no one really knows how it will play out, but down the track, these could be a tailwind. It also means that with the coming set of results, credit impairment charges could be lower than expected.
Opportunity to slash costs: The banks still have an enormous opportunity to slash costs, as digitisation and other forces drive productivity. Ultimately, the banks will have materially smaller workforces. The days of retail branches doing transactional activities are coming to an end.
Capital is strong: On the whole, the banks are well capitalised with each bank in excess of APRA’s “unquestionably strong” benchmark. The cycle of banks raising capital has come to an end and with the exception of Westpac, expect to see more chatter about capital returns, particularly if economic conditions hold up.
Interest margins: Pressure on interest margins continues. A further (and hopefully) final cut by the RBA in November of the cash rate to just 0.1% will also impact. Competition is the other force at play, with customers being “churned” from established higher margin loans and re-financed into newer, lower margin loans. A steepening of the yield curve (which is a positive factor for US banks) won’t have any meaningful impact in Australia as most borrowers are on variable rate pricing.
Fintech and the Consumer Data Right: Competition from fintechs is increasing and while this has been a slow burn to date, the consumer data right, which requires banks to make available customer credit data to approved third parties, will help to even out the playing field. And if ACCC boss Rod Sims has his way, the Federal Government will be asked to toughen anti-merger laws to stop the big banks from buying emerging fintechs.
Revenue challenges: To sustainably grow the share price, banks need to grow revenue. With anaemic credit growth, declining net interest margins and pressure to waive/reduce/scrap bank fees, this is a tall challenge. And while there remains a considerable opportunity to take out cost, there will be a point where this becomes counterproductive. Ultimately, banks will need to find new revenue opportunities, whether from business adjacencies, expansion offshore or into new markets.
Overall, the major brokers are relatively positive on the sector, with an absence of sell recommendations and upside still seen from current prices. Several brokers raised their 12 month target prices in October, which on consensus, vary from $20.20 for Westpac to $21.49 for ANZ.
Citi is the most bullish of the major brokers, with a target price of $23.50 (or higher) for each of the three majors. Only Credit Suisse has a target over $25.00, with a $26.20 call for ANZ. Macquarie is the most bearish, and retains a “sell” recommendation on NAB.
ANZ is seen to have the most upside from its current price, NAB the least. The table below (source FN Arena) shows the major brokers’ recommendations and 12 month price targets.
Getting through $20? Yes, I can see this in the next few months provided Victoria comes out of its lock-down and there is no re-emergence in Australia of another Covid wave.
Getting back to $25? Yes, I can see this by the end of 21/22. I think the responsible lending changes (if implemented) will be critical to growing volumes and revenue. If the banks can grow revenue by 3% to 4%, hold total costs flat, and keep credit impairment expenses to a manageable level because the economy doesn’t tank any further, this will bring cash earnings back to pre Covid-19 levels. This will substantiate share prices over $25.