19 October 2012 6:43am
Business loan losses will the "swing factor" in this year's bank results season and could be the source of lower than expected earnings in the results to be announced over the next few weeks.
In a preview of the bank reporting season, Morgan Stanley banking analyst Richard Wiles said banks' impairment charges had been lowered as a result of collective provision releases in both 2009/10 and 2010/11.
"We expect that trend to reverse," said Wiles. He estimates that the total impairment charge of the Big Four banks will increase from $5.3 billion to $5.6 billion.
Wiles said: "We expect slower margin decline due to loan re-pricing, lower markets and treasury income, flat half-on-half costs. On loan losses and non-performing loans, there are pockets of concern in business banking."
ANZ reports its 2011/12 result next Thursday, followed by NAB on October 31 and Westpac on November 5. Commonwealth Bank will issue a September quarter trading update on November 7.
Morgan Stanley expects ANZ to report an underlying profit of A$6 billion for the year to September – up seven per cent from the $5.6 billion underlying profit it reported last year. Return on equity is expected to fall from 16 per cent to 15.6 per cent.
It said ANZ might surprise the market with a higher than expected interest margin. On the negative side, there is a risk that loan losses will be high.
Morgan Stanley has an Underweight recommendation on ANZ. It said: "We believe its institutional and Asian profit momentum is slowing and the Asian expansion dilutes return on equity. Its business mix and risk profile make it vulnerable to higher Australian business loan losses and its Australian retail franchise is underperforming."
Morgan Stanley expects NAB to report cash earnings of $5.7 billion – up 3.6 per cent on $5.5 billion last year. ROE is expected to fall from 15.6 per cent to 15.1 per cent. NAB should show some improvement in loan losses thanks to a lower charge on its United Kingdom operations.
The business banking result is expected to be weak, but if the bank is going to produce a surprise it will be an improvement in business banking.
Morgan Stanley rates NAB Equal-weight. The stock is trading at a discount to its peers, but profit momentum is slowing and business bank loan losses are rising.
Morgan Stanley expects Westpac to report a cash profit of $6.5 billion – up 4.7 per cent from $6.3 billion last year. ROE is expected to fall from 16 per cent to 15.3 per cent. Westpac should report improved sales in retail and business banking.
Westpac is Morgan Stanley's preferred bank stock among the Big Four and is the only one with an Overweight rating. It said: "We think retail banking will outperform business banking, giving us more confidence in its margin and loan loss outlook."
Westpac is dividing opinion among analysts. In a note issued last week, JP Morgan expressed concern about whether Westpac could maintain its high dividend payout ratio while its return on equity was in decline. It downgraded the bank to a Sell.
JP Morgan analyst Scott Manning said: "Removing the impact of goodwill paid for the St George Bank merger in 2008, Westpac's return on tangible equity has declined the most amongst peers since 2007.
"Westpac is the only bank whose ROE is actually below that of 2009, when provisioning was at its peak.
"Westpac needs to draw a line in the sand at the current 15 per cent ROE to be able to 'afford' the current dividend increase."
The bank's ROE has fallen from 23.8 per cent in 2007. Westpac's payout ratio last year was 75 per cent, compared with 73 per cent for Commonwealth Bank, 69 per cent for NAB and 66 per cent for ANZ.
JP Morgan estimates that if Westpac continues to increase its dividend at the current rate of two cents per share per half year, its payout ratio will increase to 83 per cent next year and to 85 per cent by 2015.
It said: "Westpac's ROE performance may be dismissed as the drag associated with goodwill from the St George acquisition.
"The general explanation is that ROE is initially depressed via the issuance of ordinary equity to fund the deduction of goodwill from regulatory capital, only to be rebuilt over time. Westpac is yet to show signs of ROE improvement nearly four years after the St George acquisition."
"Our analysis indicates an insufficient response to the changed capital allocations required under transition to Basel III."