Major Banks: Improving outlook trumps transitory imposts
About the author:
- Author name:
- By Azib Khan
- Job title:
- Senior Analyst
- Date posted:
- 22 July 2019, 9:00 AM
- Sectors Covered:
- As a result of APRA applying a capital add-on of $500m for operational risk to each of ANZ Bank (ANZ), National Australian Bank (NAB) and Westpac (WBC), we now expect WBC to operate a discounted DRP with respect to its FY19 final dividend. We do not at this stage see the need for any DRPs for WBC beyond 2H19 from a CET1 capital perspective. Our base case remains one of no nominal dividend cuts over our forecast period for WBC.
- We have made no material changes to our cash EPS forecasts for ANZ, Commonwealth Bank of Australia (CBA) and NAB. For WBC, we have reduced our cash EPS forecasts by 1.1%/1.4% for FY19F/FY20F respectively due to now expecting an additional discounted DRP.
- WBC remains our preferred major bank. While WBC is generating the highest return on tangible equity (ROTE) of the major banks (alongside CBA), WBC is trading at a ~25% discount to CBA in terms of P/NTA multiples.
Transitory capital add-ons for ANZ, NAB and WBC
APRA last week said that it has written to ANZ, NAB and WBC advising of an increase in their minimum capital requirements of $500m each to reflect higher operational risk identified in their risk governance self-assessments.
The capital add-ons will apply until the banks have completed their planned remediation to strengthen risk management, and closed gaps identified in their self-assessments.
The increase in capital requirements follows APRA's decision in May last year to apply a $1bn capital add-on to CBA in response to the findings of the APRA-initiated Prudential Inquiry into CBA.
Base case remains one of no nominal dividend cuts
We expect the capital add-ons to result in a 16bps reduction in the CET1 ratio for NAB and WBC, and an 18bps reduction for ANZ. We expect ANZ and NAB to still be comfortably above APRA's 'unquestionably strong' benchmark of 10.5%.
In WBC's case, we now expect a DRP with a 1.5% discount to operate in respect of the final dividend for FY19.
While some investors may be thinking that WBC should cut its nominal dividend instead, we do not believe WBC should cut at this stage for the following reasons:
- the operational risk capital add-on will only be applied until planned remediation is complete;
- WBC has a sizeable franking credit balance;
- we do not at this stage see the need for any further discounted DRPs beyond 2H19 (in fact, we expect WBC to be neutralising its undiscounted DRPs in FY20F and FY21F);
- we see upside risk to our CET1 forecasts for WBC in the event of further RWA optimisation and/or reduction in IRRBB RWA.
On the earnings front for WBC, while there is downside risk to our forecasts from further customer redress and associated costs, upside risk is posed by the asset quality front as stimulus initiatives recently announced on the fiscal, monetary and macroprudential fronts may serve to push out potential deterioration in asset quality.
Furthermore, we are of the view that WBC is more progressed than ANZ and NAB on the fronts of customer remediation and re-basing of fee income.
Stimulus initiatives are serving to de-risk outlook for sector
We are of the view that the stimulus initiatives mentioned above are serving to de-risk the earnings outlook for the sector as a whole.
We believe the initiatives are positive for the outlook of system credit growth and asset quality. Furthermore, with government bond yields lower, we expect the major banks to become more attractive to investors from a yield perspective.
Changes to forecasts
We have made no material changes to our cash EPS forecasts for ANZ, CBA and NAB.
For WBC, we have reduced our cash EPS forecasts by 1.1%/1.4% for FY19F/FY20F respectively due to now expecting an additional discounted DRP. We have upgraded our recommendation for ANZ to Add (previously Hold) due to recent share price weakness.
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