Following the release of half-yearly / quarterly updates from each of the
'Big 4 Banks' this month, our sector view remains unchanged with the Focus Portfolio retaining an underweight exposure to sector.
While the banks reported sound results for 1H24, which were generally a touch ahead of consensus expectations across key line items, the sector’s medium-term earnings outlook still remains challenged.
Following modest forward upgrades, consensus forecasts still point to negative EPS growth for the ASX 200 Banks Index in both FY24e and FY25e.
In this context, the sector’s valuation premium relative to history remains excessive and unjustified at the headline level, albeit with pockets of relative value within the sector.
Capital Returns Provide Temporary Support to Earnings
The strong capital position of the Big 4 Banks has been a highlight of their interim reporting season.
All of the Big 4 remain very well capitalised by global standards on a CET1 (common equity tier 1) ratio basis and are comfortably above their APRA minimum thresholds, which has underpinned $5bn of additional capital returns announced by the Big 4 in the last month.
While capital returns from the Big 4 will be modestly accretive to EPS in the near-term, this ultimately represents a temporary ‘sugar hit’ that fails to address the still lacklustre medium and long-term EPS growth outlook facing the sector.
Bad Debts Have Been Better Than Feared (For Now)
Despite cost of living and interest rate pressures on real household disposable incomes, asset quality remains in good shape overall.
Loan arrears are unsurprisingly increasing, however, bad debts (i.e. credit impairments) have so far remained relatively low and surprised to the downside in 1H24, offering a small degree of support to earnings.
Nevertheless, there is a broad consensus among the banks that bad debts will follow arrears higher over the medium-term amidst weakening credit quality from the still percolating impact of higher interest rates on households.
While conservative provisioning provides a buffer to earnings against deteriorating credit quality, in our view there is insignificant upside to consensus earnings from potential provision releases with arrears still tracking higher and generally above historical averages.
The key swing factor will be the ultimate timing and magnitude of Reserve Bank (RBA) rate cuts.
Margin Pressures Weigh on Earnings
Weaker Net Interest Margins (NIMs) have been the biggest headwind to bank earnings over the last 12 months. NIMs remained under pressure in 1H24 amidst competitive pressures in the mortgage and deposit markets, which has more than offset the benefits of a higher interest rate environment.
However, improving market dynamics support a stabilisation in NIMs over 2H24 and FY25 with further downside seemingly limited from here. All of the major banks have pointed to easing levels of mortgage competition supported by a more stable interest rate environment and a declining level of fixed rate expiries.
While NIMs are likely to stabilise over the medium-term, risks remain skewed to the downside with limited upside potential amidst ongoing political pressure on loan rates and RBA rate cuts still likely over the next 12-18 in our view.
Housing Credit Growth Has Been Sound
Housing credit growth has been sound (albeit below trend) this year which has been a reasonable outcome amidst the tight monetary policy backdrop. During 1H24, market leaders CBA and NAB took a step back from the highly competitive (and therefore less profitable) mortgage market, while ANZ, WBC and MQG continued to gain share.
Business credit growth has been much stronger with the leading business bank NAB for example reporting +9% business credit growth in 1H24.
Our outlook for credit growth remains unchanged, with ‘trend’ to slightly above trend credit growth likely over the medium-term in our view which has already been adequately reflected in consensus expectations, albeit sooner than expected RBA rate cuts could drive moderate upgrades over FY25/6.
Sector Earnings are Set to Fall Further in FY25
In summary, while the major banks are currently on a sound footing from a capital positioning and asset quality perspective, following their interim/quarterly updates the medium-term earnings outlook for the banks remains uncompelling with negative EPS growth still expected by consensus (and us) in both FY24e and FY25e, driven by the combination of:
- Increased credit impairment expenses
- Lower net interest margins
- Operating expense growth – driven by both higher wages, as well as increased technology, risk, and regulatory spend.
Partially offset by:
- Capital management – share buybacks from NAB, WBC, and ANZ will be modestly accretive to EPS.
- Positive volume growth – system credit growth is expected to be relatively stable with more or less 'trend' growth likely over the medium-term.
Staying Underweight With Valuations Still Stretched
In summary, our view towards the banks remains unchanged post their interim results and the Focus Portfolio retains its sector underweight with a 13.5% sector exposure vs the ASX 300 at 20.6%.
In the context of a weak earnings growth outlook, on the whole bank valuations remain highly uncompelling.
The ASX 200 Banks Index trades on a forward PE multiple of 16x (skewed by CBA where we have zero weight), representing a ~13% premium to the 5-year average, and a forward price to book (PB) ratio of 1.6x, which is 14% above the 5-year average.
Given the tepid earnings outlook, the sector’s valuation premium is excessive, and implies the market expects consensus earnings upgrades. The current sector valuation (forward PE of 16x) implies the market is pricing in ~20% EPS growth in FY25 (if we assume a mean reversion to the 10-year avg PE of ~13x occurs) , compared to consensus of -1%.
This is highly unlikely to eventuate in our view without a dramatic shift in RBA policy rate expectations and the economic outlook, demonstrating the extent of the sector’s current valuation excesses at current levels.
Focus Portfolio Positioning - Remaining Selective
The Focus Portfolio is selectively positioned within the banks where relative valuations are most compelling. The portfolio has an overweight exposure to ANZ (6% portfolio weight), is neutrally positioned in NAB (4.5%) and WBC (3%), and has zero exposure to CBA.
ANZ Group (ANZ) is our preferred bank exposure (6% weight)
ANZ is the Focus Portfolio’s largest bank position, given:
- Attractive relative valuation – ANZ offers the most attractive relative valuation among the Big 4 on both a PE multiple and P/B ratio basis, and offers an attractive forward dividend yield of 5.9% (or 7.6% grossed up).
- Superior capital returns – On a CET1 basis, ANZ currently has the strongest balance sheet out of the Big 4. This has underpinned its $2bn on-market buyback which is the largest buyback that has been announced in the sector and will be accretive to its EPS and ROE over 2H24/FY25.
- Institutional strength is a differentiator ANZ’s leading institutional segment, which is its largest earnings contributor (43% of group cash earnings), diversifies the group’s earnings mix and lessens its exposure to the competitive mortgage market. In 1H24 ANZ benefited from the strength of its institutional segment which posted cash earnings growth of +12% vs 2H23, partially offsetting weakness in Australian retail banking.
- Above system home lending growth ANZ has been gaining share in the Australian home loans market, growing at 1.5x system in 1H24. The (pending) integration of Suncorp Bank will (if successful) enhance the bank’s scale further by adding $60bn in customer loans to its balance sheet.
National Australia Bank (NAB) (4.5% weight)
NAB remains a key bank exposure given its quality (above average forward ROE of 11.4%), it’s leading business banking segment (a key differentiator providing less exposure to the competitive mortgage market), and its attractive relative valuation compared to market leader CBA (P/B ratio of 1.6x vs 2.5x respectively).
Westpac (WBC) (3% weight)
WBC is held in the Focus Portfolio primarily due to its attractive relative valuation, with the bank trading at a forward P/B ratio of 1.3x, below the Big 4 (ex WBC) average of 1.8x. WBC also offers an attractive forward dividend yield of 5.9% (or 8.5% grossed up).
Commonwealth Bank (CBA) (not held)
Despite CBA being a high-quality bank with a sector-leading ROE, the company’s valuation premium to peers (and history) is excessive.
CBA trades on a forward PE multiple of 21x, which is a 52% premium to peers and a 30% premium to the ASX 200 Index, while CBA's forward divided yield is below the ASX 200 market yield of 4.0%
While a premium is deserved for quality, the extent of CBA’s valuation premium is unjustifiable when considering CBA’s weak medium-term EPS outlook, which is below the bank sector average on a comparable basis over the 2024 and 2025 calendar years, and is also lower than broader market (ASX 200) EPS growth expectations over the same time frame.
| Company Name | Ticker | Portfolio % | 12 mth fwd valuation multiples | EPS growth (diluted, operating) |
Dividends - 12 mth fwd | ||||||||
| Weight | Active Weight* | P/B | +/- vs 5yr avg | P/E | +/- vs 5yr avg | 1H24a surpise vs consensus | FY24e | FY25e | 12mth fwd yield | Franking | Grossed up yield | ||
| ANZ Group | ANZ | 6.0% | 2.3% | 1.2 | 10% | 12.6 | 6% | 9.1% | -8.3% | 0.0% | 5.9% | 69% | 7.6% |
| National Australia Bank | NAB | 4.5% | 0.1% | 1.6 | 21% | 15.1 | 14% | 2.6% | -6.6% | -0.1% | 5.0% | 100% | 7.1% |
| Westpac Banking Corporation | WBC | 3.0% | -1.1% | 1.3 | 13% | 14.0 | 12% | 2.2% | -6.0% | -0.5% | 5.9% | 100% | 8.5% |
| Commonwealth Bank of Australia** |
CBA | 0.0% | -8.4% | 2.5 | 19% | 21.1 | 18% | -0.4% | -1.8% | -3.3% | 3.8% | 100% | 5.5% |
| Big 4 Banks | 13.5% | -7.1% | 1.6 | 14% | 15.9 | 13% | -4.3% | -1.4% | 4.8% | 94% | 6.6% | ||
*Active weight vs ASX 300 weight. **CBA has a June year end, while NAB, WBC, and ANZ have September year ends.
Source: Refinitiv, Visible Alpha, Wilsons Advisory.
Written by
Greg Burke, Equity Strategist
Greg is an Equity Strategist in the Investment Strategy team at Wilsons Advisory. He is the lead portfolio manager of the Wilsons Advisory Australian Equity Focus Portfolio and is responsible for the ongoing management of the Global Equity Opportunities List.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
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