What’s Ahead for Bank Shares?

Bank stocks never seem to be out of the news for long. On one side, they attract constant rumblings about the size of their profits. On the other, speculation about whether they’ll be able to maintain their high dividend payout ratios.

I suppose it all comes down to what side of the fence you’re on.

The banks have been very successful at ratcheting up their profits year after year. This financial year, the big four collectively took home over $31 billion in profits — a near 8% jump on the year before.

However, there’s a growing chorus who now believe that the best times are behind them. Fitch, the global ratings agency, are the latest to get on board. They argue that there are two main reasons leading to lower bank growth.

First, the continual unwinding of the mining boom. And second, the housing market finally looks like it is starting to cool. Adding to the pressure, Fitch believe that the banks’ net interest margins are being squeezed just as their revenue growth is beginning to slow.

Adding to their problems, all four have needed to raise capital, making it harder for them to maintain earnings per share growth.

Of course, none of this is news to the market. All four are now trading around 20% lower than the peak back in March and April. The real question is: where do the banks go from here?

After Westpac raised their variable mortgage rate by 0.2% a few weeks ago, it was never going to be long before the others followed. And follow they did. Commonwealth Bank [ASX:CBA], NAB [ASX:NAB] and ANZ [ASX:ANZ] soon announced an increase in their base rates between 0.15% and 0.18%.

Westpac’s move didn’t take long to cause the ire of Treasurer Scott Morrison. And you can understand his frustration. It was the last thing he needed at a time when the economy is struggling to gain any momentum.

The move by Westpac certainly caught the RBA by surprise. If nothing else, it put them in a tight spot. Many speculated that this would force the RBA to lower the cash rate at their Melbourne Cup day meeting. Something to keep the economy shuffling along.

Had they decided to lower the cash rate, the RBA would have been put in the position of being seen to be underwriting the banks’ profits. Certainly not something they’d want to do.

Apart from highlighting the power the banks hold over the economy, it also showed us what the banks are prepared to do to protect their profits. All blamed the increased capital requirements on the government and regulators.

Brian Hartzer of Westpac was pretty blunt in his comments:

The government, the regulators decided that they wanted the banking system to be unquestionably strong, we accept that decision…We simply noted all along the way that ultimately, that would come at a cost that would need to be shared across our stakeholders.

Stakeholders? Well, I guess that means everyone else apart from them. When it comes to who was going to pay for the cost of the new regulatory framework, the answer was always the customer.

What does it mean for shareholders in the banks? The answer is in two parts. When you look at total returns, there is both capital growth and the dividend yield.

The banks will be able to nudge up rates (and cut costs by redundancies) to try and maintain their profits. This will support the dividends they’re able to pay to their shareholders. However, it’s a fine line. Raise them too much and that could lower the level of lending activity. The very thing that drives their business.

Bank share prices have had a stellar run. But it’s going to be harder for them from here. A larger capital base makes it harder to achieve the high returns on equity that they’ve enjoyed in the past. This comes at a time when the property market might finally have peaked.

What’s ahead? More of the same. The odd rally that runs out of puff, just as any decent selloff will attract yield hungry investors, putting a floor under the price. What is more certain, is that the prices will still get knocked around with any periods of increased volatility — like we saw in August.

With NAB going ex-dividend today, soon to be followed by ANZ and Westpac, I’m watching how far their share price falls. Last year, they had a good run up before dropping by as much as the dividend again after they went ex-dividend.

This year has seen much more subdued buying from those chasing dividends.

That being said, bank stocks will still form part of an income portfolio. Until the economy starts growing again, though, they might not enjoy the huge capital gains they’ve experienced in the past.


Matt Hibbard

Editor, Total Income

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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