Two second tier banks that stand out
As would only be expected in a recession, there is a lot going wrong for Australia’s major banks, and the marked-down share prices reflect that.
The economic damage resulting from the COVID-19 pandemic has had a major impact on the banks, and on investors’ view of them. Who would have believed, prior to COVID, that the Australian Prudential Regulation Authority (APRA) would tell the banks (which paid out more than 80% of their profits as dividends over the past five years) to “materially reduce” their dividends?
It could have been a lot worse. APRA’s European equivalents actually ordered banks to stop paying dividends altogether during the crisis, and that actually tells us that Australia’s banking system entered the Coronavirus crisis in a much stronger position than Europe’s. APRA’s instructions to banks to limit their dividend payout to no more than 50% of profits would be considered “soft-touch” in Europe.
But Australian investors have had to get used to the end of what many had (erroneously) viewed as an ever-increasing dividend stream from the banks, with Commonwealth Bank pruning its final dividend by 57%, ANZ and National Australia Bank both cutting interim dividends by 70%, and Westpac confirming that it would not pay an interim dividend at all, and saying it would reassess dividend payments at its full-year results in November.
The banks have been hammered, but the paradox there is that both the prudential regulator and the government fully understand that Australia will need the sector to be in as strong a shape as possible, to help firstly to stabilise a weak economy, and then, to foster recovery on the way out of COVID.
Hence the government’s lending reforms announced last week, in which it was determined to make it easier for consumers and small business owners to get bank loans. To do so, it effectively scrapped the “responsible lending” laws introduced after the GFC. Quite simply, the government is prepared to prioritise access to credit, so that more individuals can buy their own homes, and more businesses can spend more money to stimulate the economic recovery that the nation needs.
It’s good news for the banks, but they no longer have it all their own way, with non-bank lenders booming and wholly digital neobanks emerging. Neobanks have very low overheads and rely on technology platforms to make them faster, cheaper, and more accessible than a traditional bank.
Many investors won’t want to go past the big four banks, for brand name strength, and I get that. Even with the dividends having to be pruned, the big four still offer, on analysts’ consensus expectations, dividend yields of 3.8%–4.6% for FY21, or grossed-up, 5.4%–6.3%. Many investors, particularly self-managed super funds (SMSFs), will still see that level of yield as core income-generating portfolio holdings. Notwithstanding the disappointment that these grossed-up yields have come down from high-single-digit (even double-digit) yields that such investors enjoyed until relatively recently. In this context, it was especially eye-opening in November last year when ANZ bit the bullet and only partially franked its final dividend to 70%, saying that the move reflected a declining share of Australian-business earnings in its overall profit pool.
Three of the big four banks – ANZ, National Australia Bank and Westpac – look to be reasonable buying on a total-return basis, with their yields augmented by analyst expectations for share price gains in the 10%–20% range. CBA trades much closer to fair value, in this respect.
Of the others, ANZ looks to offer the best value from a total-return basis, although it is no longer a fully franked dividend payer. With a forecast nominal yield of 4.6% in FY21 (September) grossing-up to 6.2%, and FN Arena’s analyst consensus valuation almost 20% above the current share price, that’s where I’d be looking in the big banks, with leverage to an improving economy.
But investors shouldn’t ignore some of the value in the second-tier banks – and two in particular stand out.
1. Suncorp (SUN, $8.59)
Market capitalisation: $11 billion
Five-year total return: –2% a year
Analysts’ consensus estimated yield FY21: 5.1%, fully franked (grossed-up, 7.3%)
Analysts’ consensus valuation: $10.26 (Thomson Reuters), $10.48 (FN Arena)
Suncorp would prefer to be thought of as a bank with an insurance arm attached, not the other way around. The owner of Suncorp Bank also owns a swag of insurance brands – including AAMI, GIO and Bingle – and as a result, it took a natural-hazard hit of $820m from the bushfires and other disasters in its FY20 result. Outside that, total cash earnings fell by 33% to $749m, while the banking and wealth division reported a net profit of $242m, down 33.5%, hurt by higher provisions.
The total FY20 dividend was almost halved, at 36 cents, on a dividend payout ratio of 60.7%, less than FY19’s 81.2% payout. Suncorp estimated that the effect of COVID-19 on its FY 2020 results to be around $140 million, while it benefited from an estimated $140 million reduction in motor claims, given the reduction in car usage.
All things considered, it was actually a fairly strong result, and analysts like the look of the company’s prospects coming out of COVID-19. Suncorp closed branches representing 17% of its physical network across Queensland, New South Wales and Victoria in FY20, as it moves its business more online (most of the closed branches had been shut since April when COVID-19 restrictions came into place). Suncorp said this was simply the way that its business was evolving. It said that over-the-counter transactions were down almost 60% since June 2016, and two-thirds of new accounts are now opened online. Investors want to see this ability to focus on customer needs and match the digital players for convenience. Suncorp is a strong alternative to the major banks.
2. MyState (MYS, $3.74)
Market capitalisation: $344 million
Three-year total return: 2.8% a year
Analysts’ consensus estimated yield FY21: 6.8%, fully franked (grossed-up, 9.7%)
Analysts’ consensus valuation: $4.30 (Thomson Reuters)
Tasmanian-based bank MyState announced in August the closure of all of its branches outside its home state, to prioritise the digital and mortgage broker business channels. MyState had four Central Queensland branches as a legacy of its takeover of The Rock Building Society in 2011, but the same forces that are at play with all banks (digital convenience and declining in-person transactions) made the decision for the bank, with the pandemic having only accelerated them. MyState is a quiet success story in Australian financial services. More than 60% of the home loan book is now outside Tasmania, with the home loan portfolio growing by 5.1% to $5.1bn in FY20, while deposits increased by 7.6%, to $3.9bn.
MyState reported a net profit of $30.1m for the 12 months to June, down 3%, and took an impairment charge of $4.9m (half of that a COVID-19 overlay and half an increase in the general reserve). Without the charge, earnings would have been up 12.9%. The group did not declare a dividend for the June half, and has reset its target dividend payout ratio from 70%–90% of earnings to 60%–80%. MYS has had its difficulties in recent years, but it is a well-run business (it includes the TPT Wealth division) that is nicely positioned for the recovery out of COVID-19.