Banks: Pricing inefficiency there to be exploited
About the author:
- Author name:
- By Azib Khan
- Job title:
- Former Senior Analyst
- Date posted:
- 04 February 2021, 9:30 AM
- Sectors Covered:
- We expect the upcoming round of reporting to surprise on the upside and result in increased investor confidence in the banks.
- We expect the valuation gap between Commonwealth Bank of Australia (ASX:CBA) and Westpac Banking Corp (ASX:WBC) to narrow.
Upside risk to our earnings and dividend forecasts despite being more optimistic than consensus
While we continue to appear to have the lowest FY21 credit impairment charge forecast on the street for each major bank, we believe our forecasts are looking increasingly conservative. That is, we are seeing increasing upside risk to our earnings and dividend forecasts for FY21.
In the upcoming round of reporting in February, we do not expect any of the major banks to adversely revise the base case macroeconomic assumptions for expected credit loss (ECL) provisioning.
We also do not expect the banks to adversely revise the probability weights assigned to each ECL provisioning scenario. In fact, we see potential for favourable revisions to macroeconomic assumptions and probability weights in the Dec-20 quarter.
This is because the unemployment rate and house prices have fared better than assumed in the banks’ base case scenarios for provisioning. In fact, National Australia Bank's (ASX:NAB) CEO made a point at the AGM in December that “the current economic picture reflects what we considered ‘best case’ in our scenario planning from earlier in the year”.
While we see potential for collective provision releases in the Dec-20 quarter based on macroeconomic developments, it is likely that the major banks will choose to remain conservative with provisioning over coming months particularly as JobKeeper is set to come to an end on the 28th of March 2021 and a vaccine rollout is yet to commence in Australia.
Although we may not see provision releases in the upcoming round of reporting in February, we nonetheless see an increasing likelihood of credit impairment charges being quite minimal, creating upside risk to our earnings and dividend forecasts for FY21.
Upcoming round of reporting to boost investor confidence in banks
We expect the upcoming round of reporting to boost investor confidence in the outlook for asset quality, dividends and capital management. As this happens, we expect investors to pay more attention to the relative valuation of each major bank and the dividend yield on offer from each major bank.
Expect narrowing of valuation gap between CBA and WBC
With investor confidence in the major banks being hit with the onset of the pandemic, we believe CBA’s share price benefitted substantially from the perception that it has the best risk profile.
However, as investor confidence in banks increases, we believe investors will place a more normal weighting on risk profiles and pay more attention to valuations.
Consequently, we expect CBA’s share price to underperform the other major banks and we expect WBC’s share price to outperform the other major banks over the next 12 months.
Out of the major banks, we believe WBC’s overall risk profile is second to CBA. Both CBA and WBC have their loan books positioned relatively defensively with a skew to Australian home lending.
We believe CBA and WBC are delivering similar underlying ROTEs. However, even after adjusting for differences in CET1 capital ratios, CBA is trading on a P/NTA multiple premium of ~60% to WBC, and CBA is offering a notably lower dividend yield.
We expect this valuation gap between CBA and WBC to narrow over the next year.
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