Expecting mid-single-digit underlying EPS growth
We generally expect mid-single-digit EPS growth over the next 3 years; by 'underlying' we mean excluding remediation costs and one-off regulatory costs. While we do expect more remediation charges from each of the major banks, we do not expect the magnitude of further remediation charges to be large enough to result in nominal dividend cuts or capital raisings (other than dividend reinvestment plans) in the cases of WBC, ANZ and CBA. Our base case remains one of no nominal dividend cuts for these three banks.
In NAB's case, we expect the nominal dividend to be cut as we see earnings headwinds building following the departure of its CEO together with a stretched dividend payout ratio and relatively weak CET1 capital position.
Expecting low bond yields to boost share prices
In addition to the underlying growth and attractive dividend yields on offer, we are also positive on the sector due to the declining government bond yields across the developed world. We expect the lower bond yields to be sustained with the US Federal Reserve, European Central Bank and the RBA adopting significantly more dovish stances now compared to CY2018.
We expect the lower bond yields to be supportive of major banks' share prices as the attractive dividend yields on offer make the majors, in our view, strong yield play candidates.
Recession risk key reason to be cautious
While we have a positive stance on the major banks sector, we are mindful of the increasing recession risk in Australia. Although we expect economic stimulus to be provided in time to avert a recession and prevent material asset quality deterioration, the risk is that the governments (Federal and State), RBA and APRA wait too long before acting.
Concerns about the asset quality and margin ramifications of Westpac's (WBC) relatively high interest-only home loan exposure continue to weigh on its share price multiples in our view. However, we continue to believe these concerns are overblown. WBC has reduced its interest-only exposure to 50% of its Australian home loan book at Mar-2017 to 32% at Dec-2018 without its asset quality underperforming peers in any material way and its group Net Interest Margin has been broadly flat over this period (excluding the impact of customer remediation charges). While we acknowledge that switchings from Interest Only to Principle & Interest are margin headwinds, we expect the impact of the switchings on ROE to be more muted once APRA announces its new capital framework. Also, we believe the bearish views on WBC's Interest Only exposures have generally accounted for the fact that a significant chunk of WBC's Interest Only exposure reduction over the last 2 years is attributable to external refinancing, and we expect this to continue to be the case over the next 2 years as long as securitisation markets remain buoyant.
We retain our Add recommendations for WBC, ANZ and CBA. We retain our Hold recommendation for NAB. WBC remains our preferred pick in the sector.
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