Australian Banks are classified as some of the strongest banking institutions in the world. It would be no surprise to readers that we would recommend that any half decent portfolio should incorporate exposure with the banks. They pay high dividends, are fundamentally sound and as we have recently experienced, were able to ride through the worst financial crisis the world has experienced since the Great Depression of 1929.
However, and this is a big ‘however’, the outlook for the Banking sector is not one of growth potential. This sector will experience limited growth heading into 2012 even though leading companies will maintain strong earnings. The impact for investors is that we recommend an “Underweight” exposure to the Banks.
The 4 leading Banking companies, referred to as the “Big 4”, represent approximately 20% of the S&P ASX200 index. This has a direct impact to any investor who has a heavy weighting of these Blue Chip stocks in their investment portfolio. At the same time, institutions must include sizable positioning of these companies in their portfolios.
The factors that made the Banks fantastic investments before the Global Financial Crisis (GFC) are no longer evident. As stated by the RBA in their recent Financial Stability Review, “the very rapid growth in the financial system over the years that preceded the crisis seems unlikely to be repeated, since to a significant degree it represented a one-time adjustment to financial deregulation and the shift to low inflation”. If that view is correct, then banks’ domestic growth opportunities will be more limited in the years ahead.
Credit Defaults were the cause of the GFC, with leading institutions having too much exposure to debt risk. Post GFC, lending has become much tighter. Criteria for borrowing is far more stringent and subsequently we have seen a decrease in credit both on a personal level and on a business level. As stated by the RBA; “Growth in deposits continues to outpace growth in credits”.
The trend following the GFC has been for consumers to tighten their spending, to save and to pay-down credit debt. This has led to fewer loans being written, which will subsequently mean decreased interest for the banks.
The attraction of investors to the “Big 4 Banks” is that they are fundamentally stable (therefore, they are considered lower long-term risk), and they are high paying dividend stocks. The following table defines the most recent dividend payments:
Big 4 Dividends
|Bank||Dividend||Dividend Yield||Ex Div date|
|CBA||$1.32||5.9%||14th Feb 2011|
|NAB||$0.78||6.4%||12th Nov 2010|
|ANZ||$0.74||5.4%||4th Nov 2010|
|WBC||$0.74||6.1%||8th Nov 2010|
Maintaining strong dividends will be difficult as Revenue generation will be hindered on multiple levels:
- We expect higher energy costs to put pressure on the stock market in the latter half of the year. This will impact on the profitability of the banks. Although they will continue to remain profitable, we cannot expect the same performance as in previous years. With slowing economic growth, the banks will experience slowing profit growth.
- The recent natural disasters are unlikely to have an impact on the assets of the Banks. However, profits are likely to be affected on the claims through insurers.
- Expected slower pace of credit growth compared with the previous few decades, which historically (20 years) is 11 to 12%
- Consumers are saving at a much higher rate and reducing their debt.
- High entry into the property market is limiting growth in loans, along with tighter lending criteria
- The small business lending market has also eased. Loans are 2% (200 basis points) higher than cash rates, causing greater pressure on the small business sector. As most business lending is against residential property, the impact of a softening Property sector provides less equity to lend against.
Analysis of the different revenue streams provides some insight into how much impact each of the Big 4 will experience. The following table outlines their exposure:
|Bank||Retail Banking||Institutional Banking & Markets||Business & Private Banking||Wealth Management||Others|
|WBC||36.4%||19.5%||10.2% (BT Financial Group)||34% (inc St George Bank)|
ANZ has greater diversification across the different sectors of the Banking industry. Whereas NAB is heavily exposed to Retail Banking, and likely to suffer limited growth opportunity.
It’s hard to see the Banking sector outperforming Mining in light of this evaluation. Where there is further growth potential in Mining due to the demand for resources specifically from China, the Banking sector, whilst remaining profitable, does not have the same growth outlook.