The Big Four banks significantly underperformed the ASX 200 this week, falling 6.1 per cent. Most of the move was concentrated on Tuesday and Wednesday following the release of half-year results from National and ANZ respectively. NAB finished the week down 6.4 per cent and ANZ 6.6 per cent, while Commonwealth fell 5.1 per cent and once unstoppable Westpac fell 6.3 per cent ahead of its result next week.
Over the course of the week brokers have fiddled their bank share price targets, but no one bank has seen any significant change to the average. What is notable, however, is that after several weeks trading at premiums above their broker average targets - premiums of up to or exceeding 10 per cent - bank share prices have now given up most of these premiums. If Thursday hadn't seen such a strong day for the Australian share market, three of the Big Four would now probably be trading without any premium at all.
At the close on Thursday, Westpac and CBA were trading at reduced premiums of 2.5 per cent and 5.2 per cent respectively, while ANZ and NAB are both smack on their target.
This is as FNArena predicted. FNArena has simply observed that over the few years of its existence, every single time bank stocks overrun their average broker targets (being the mean of the targets of the top ten experts surveyed by FNArena) it is the bank share prices that always fall back, and not the targets which rise. Targets may rise at some later date, but not until bank shares have suffered a "blow-off top" in their rally. The rule is yet again confirmed.
On a less mathematical note, we warned last week that the upcoming bank results would be all about quality, not quantity - about earnings but with an emphasis on bad debt growth. Bad debt growth remained a wild card amongst earnings numbers which were otherwise easier for analysts to forecast. And this has proven very much the case.
On release of the NAB result, analysts were taken aback by a significant increase in loan impairments. Citi analysts noted "across the board credit quality deterioration". ANZ also shifted a large amount from its general provisions against danger into its specific provision against impaired loans.
We also warned last week to watch out for accounting tricks. ANZ has caused controversy by redefining its earnings to exclude the volatile mark-to-market cost of offshore intermediation funding from what was once the common benchmark of "cash earnings". This meant that operationally, ANZ's earnings rose around 10 per cent for the half. However counting back to the old cash earnings benchmark, the bank missed consensus broker forecasts by 20 per cent. It is this number which caused most of the consternation on Wednesday, and sent ANZ shares tumbling more than seven per cent.
Take the numbers as you will, but either way both ANZ and NAB posted operational earnings results that exceeded expectation. This was not a huge surprise because analysts had already flagged a healthy increase in commercial banking revenues for the half, driven by the increased market share picked up by the Big Four in an otherwise declining credit market, and by increased margins. Increased margins have come about both as a result of the RBA rate cuts and the failure of banks to pass on all of the cuts into mortgage rates, and virtually none into business loan rates, and from the increased deposits the Big Four have enjoyed since Australians have reverted back to saving money in a recession. An increased deposit base reduces a bank's need to source expensive offshore funding from intermediation markets.
This "purple patch", as RBS analysts describe it, has helped to cushion bank balance sheets in the first half against the rising tide of bad debts. Nevertheless, improved revenues have been undercut by bad-debt write-offs and the need to increase impairment provisions. Yet while NAB made such an increase to its general provisions, ANZ did not.
This was another source of consternation from the market and another reason why ANZ shares were sold off so heavily. How can ANZ not increase its provisions when, according to its own guidance, bad debts are expected to rise as the recession hits home and unemployment rises?
While some brokers fretted, others pointed out that ANZ had been putting away extensive general provisions - labelled at the time as provisions against further credit crisis-induced weakness - for the past eighteen months. ANZ has been the leader in the provision-build among the Big Four, leaving others in its wake. It was these provisions that sent ANZ shares into a deep discount against the two preferred banks - Westpac and CBA - over the course of 2008. At the time, bad debts were all about big-name implosions - Allco, Centro, Babcock and Brown, ABC Learning and co - all of which were big hits to bank balance sheets. When ANZ significantly increased its provisions, the market feared the worst. Who was next? What did ANZ know?
But that was not the case at all, as it turns out. There have been no further big-name implosions, just as bank CEOs had suggested this time last year. What has instead happened is we have moved from Phase I of bad debt growth - being the big names - into Phase II - being a broader increase in loan defaults and delinquencies from smaller businesses. Yet to come is Phase III - growing defaults at the consumer level as unemployment rises. These phases are typical of any recession cycle.
Thus, while ANZ moved $300m from its general provision into its specific provision against bad debts, it did not top up its general provision because management felt it had already provided well enough. ANZ still leads provisions amongst the Big Four on a relative basis, while analysts are concerned that NAB was forced to make a big increase this week which may yet prove insufficient, and that CBA (which reported back in February) is the least covered.
Bank analysts have already begun to grow nervous about the recent 25 per cent rally in bank stocks and had moved more bank ratings to Sell than Buy. This week Macquarie downgraded NAB from Outperform to Neutral and Citi downgraded NAB from Hold to Sell. Citi also downgraded ANZ from Hold to Sell.
Bank analysts largely agree that the "purple patch" is now nearing its end. Market share has realigned back in favour of the big banks and away from foreign banks, smaller banks and non-bank lenders. This cushion against a general fall in demand for credit will become less of a factor from here on and the big banks will suffer a loss of revenue along with everyone else as credit demand continues to fall. With offshore funding still holding up at high levels, it will be bad-debt growth which will make or break local bank balance sheets.
Since the credit crisis began in earnest, the Big Four have increased deposits, raised capital, underwritten DRPs and cut dividends, including cuts to both NAB and ANZ dividends this week. Tier one capital ratios are now comfortably over the 8 per cent mark, but loan impairments are "capital intensive" and those ratios will remain under threat until sure signs emerge that bad-debt growth is slowing. As is still the case in the United States, Australian banks may yet need to go to the market for fresh capital before this recession is over.
On the matter of US banks, stand by for "stress test" results next week, due May 4.
We also now await the Westpac result next Wednesday, and we also have Macquarie reporting its full-year result this Friday.
As this report goes to print, we will have had another night on Wall Street, which may determine whether the ASX 200 can finally leave the brick wall at 3779 behind (3780 is not enough) and overcome what looks like stiff program selling at 3800. A significant breach could well see another leg up in this rally, but that would require the Big Four bank stocks to once again stretch into premiums over average broker targets. And each week more brokers are shifting to Sell ratings on more banks.
20090501 bank wrap tab
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