Current market conditions should support big bank profits in the near-term, but analysts from Morgan Stanley are concerned about the outlook for the 2019 financial year.
Morgan Stanley currently has a “negative stance” on the major banks, which is perhaps consistent with its bearish view for the Australian economy more broadly.
The analysts cited loan re-pricing and stable credit quality — with recent data indicating fewer Australians are falling behind on their interest repayments — as a current positive for earnings.
The longer-term outlook is less rosy. This table summarises Morgan Stanley’s mid-range price targets for the big four as at December 2018, compared to prices recorded today in afternoon trade:
It’s far from optimistic — and in the case of Commonwealth Bank, Morgan Stanley is forecasting a fairly significant price depreciation.
“We are underweight CBA, given a declining return on equity (ROE), less strategic clarity, slower home loan growth, conduct concerns, an earnings hole from asset sales, and full trading multiples,” analysts said.
In justifying their position, the analysts outlined five structural factors which will serve to decrease ROE among the big four banks:
1. Industry in transition: Morgan Stanley said the big banks can no longer rely on market power and consistent house price growth to underpin returns.
Instead, recent efforts by regulators to ensure financial stability and address community concerns will put a cap on future earnings.
2. Challenging revenue outlook: Morgan Stanley expects margins will peak in the next six months, before housing loan growth slows in the second half of the year.
Already, reports indicate that the big banks have built a $600 million war-chest in preparation of increased price competition for home loans.
3. Disruption from innovation: New technology such as real-time payments and mobile banking present both opportunities and threats to the sector, but Morgan Stanley said Australia’s big banks lag their global peers in this space.
“We believe that the majors need to lift near-term investment before they can pursue a step change in cost savings, and that the improvement in Australian efficiency ratios will be “slower than the curve” globally,” analysts said.
4. Increased scrutiny: Earlier this month, UBS analysts listed 15 major inquiries currently facing Australian banks. And Morgan Stanley said current earnings estimates aren’t fully capturing the downside risks stemming from levels of legal and regulatory oversight.
5. Dividend growth will remain subdued: Morgan Stanley cited opportunities for capital management, highlighting ANZ’s recent asset sales which will free up cash for share buybacks.
However, lower projected returns and higher capital ratio requirements means payout ratios will “remain elevated, and dividend growth is hard to justify”.
Morgan Stanley’s ranking of the big four banks in order of preference is Westpac, ANZ, NAB then Commonwealth Bank.
“In our view, WBC offers less uncertainty and execution risk than peers given a settled strategy, good margin management, consistency on costs and an improved capital position,” analysts said.
Westpac is the only bank among the big four in which Morgan Stanley holds an overweight position. The analysts are neutral on ANZ, and are underweight both NAB and CBA.