Banks posted record profits in 2010 but earnings growth in the coming year may
be difficult as the big four prepare to compete for funds with heavily indebted
foreign governments.
Westpac made Australian history with a $6.3 billion net profit that pushed the
big four banks' combined profits to $21 billion in 2010. This was due largely
to falling bad debts as the banks emerged from the economic slowdown prompted
by the global financial crisis.
But analysts warn earnings may be depressed in 2011 as higher funding costs
pressure the margins of the big four - Commonwealth Bank of Australia, Westpac,
ANZ Banking Group and National Australia Bank.
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On top of the competition from foreign governments in the coming years, the
banks are having to refinance their debt at higher post-GFC rates and will pay
a premium for longer-term debt as they seek to lock in funding.
"There's going to be a lot of demand for longer duration bank debt than what
we've seen in the past," CLSA Asia Pacific analyst Brian Johnson said.
Credit Suisse's Jarrod Martin and James Ellis warned local banks could be
crowded out.
This is at a time when the local banks have a huge funding requirement, with
CBA and Westpac the fourth and fifth biggest borrowers in global debt markets,
UBS analyst Jonathan Mott said.
The past decade saw banks lend more money to home buyers and businesses in
Australia without matching the lending with savings. The funding gap was filled
by a growing reliance on offshore debt markets.
When the GFC weakened regional banks and caused non-banks to fail, the role of
sourcing foreign capital to fund the domestic economy fell increasingly on the
big four.
In 2010 the big four passed on interest rate rises to protect margins after
funding costs climbed after the GFC.
Now a greater challenge lies ahead: having to compete harder in offshore credit
markets against global banks and heavily indebted northern hemisphere
governments expected to issue debt aggressively from 2012.
"Banks could find their access to flows of wholesale funding diminishes below
critical minimum requirements (their annual re-financing tasks) which cannot
easily be replaced by other funding sources," Messrs Martin and Ellis said.
"Ultimately that cost would be passed through to borrowers," Fat Prophets'
analyst Colin Whitehead said.
So banks are under pressure to diversify their funding sources.
Lenders spent much of 2010 competing for more retail deposits and lobbying the
federal government to allow the issue of covered bonds.
Southern Cross Equities analyst TS Lim said with interest income still
comprising two-thirds of total income, banks will keep diversifying into wealth
management and institutional banking products and services.
"They're probably ... trying to position themselves for a new paradigm in
banking."
Treasurer Wayne Swan's inclusion of covered bonds in his bank competition
reform package was applauded by the market as a step toward easing funding
pressures.
Covered bonds operate in a similar way to residential mortgage backed
securities but are backed by mortgages or public sector loans sitting on banks'
balance sheets, making them a more conservative funding alternative than
securitisation.
If backed by mortgages, these are ring-fenced for possible sale if the bank
cannot meet its obligations to covered bond holders, but are also protected
from bank depositors if the bank collapses.
Other parts of the reform package, such as the proposal to ban mortgage exit
fees, will ease pressure on consumers but slightly strengthen bank revenue
headwinds.
NAB and ANZ have already scrapped these fees, and ANZ chief executive Mike
Smith told the Senate inquiry into banking competition that his bank would
absorb this cost.
CBA chief executive Ralph Norris told analysts in November that revenue lost
from ATM and exit fees were "immaterial".
"But all these things mount up," he added.
Consumers may win if exit fees are axed but they will lose as funding costs
continue pushing interest rates higher.
Mr Norris told the Senate inquiry there was "no doubt" interest rates would rise
by 75 to 100 basis points in 2011.
This will pressure already stressed borrowers who drove an increase in mortgage
delinquencies across all six states by September 30, according to credit agency
Fitch Ratings.
While falling bad debt provisions on business loans allowed bank profits to
recover in 2010, Mr Lim warned that bad debts from consumers typically peak
four years after any crisis and are still ahead for the big four.
"There will be some tail effects on the personal lending side - some residual
asset losses," he said.
Sluggish credit growth and revenue headwinds are also expected to weigh on
earnings in 2011.
Weak credit growth means most analysts expect low earnings growth for CBA and
Westpac, given their large exposure to domestic retail banking customers and
small businesses.
ANZ's access to Asia's trade flows and customer deposits make it the analysts'
top pick in 2011, while earnings for Australia's biggest business lender, NAB,
will depend on a resurgence in business credit growth.
Cost growth is expected to outpace revenue growth, but all eyes will be on the
pace of any recovery in business credit growth as key to banks' 2011 earnings
and share prices.
Businesses are still cutting debt and thus restricting credit demand that will
delay the banks loan pipeline until the second half of fiscal 2011 and
discouraged confident outlook statements.
"Eventually it has to happen," ANZ's Mr Smith said.
"Corporates are going to have to start to term-out some debt."
A silver lining for shareholders may come in the form of higher dividends from
banks holding excess cash previously reserved to fund business loans.
Mr Mott and Mr Lim said banks were keeping dividend payout ratios at 65 to 70
per cent of earnings and have room to increase them.
CBA analyst Ben Zucker expects earnings-per-share growth of 8.5 per cent in
fiscal 2011 and a dividend yield of 6.3 per cent; while Mr Mott says EPS will
be mid-single digits for five years, down from eight to 12 per cent before the
GFC.
Mr Martin and Mr Ellis warn of negative momentum for bank stocks from higher
interest rates and tighter lending standards.
AAP
