Billions in dividends, strong earnings and more to come

Buy Hold Sell

Livewire Markets

The banks are back, baby. Or so it seems. National Australia Bank (ASX: NAB), Commonwealth Bank (ASX: CBA), ANZ Bank (ASX: ANZ), and Westpac (ASX: WBC) have handsomely rewarded investors for their patience during tumultuous 2020, with nearly $7 billion in dividends expected to flood the market over the coming months. 

The good news doesn't stop there. Or at least, that's according to Wilson Asset Management's Matthew Haupt and Firetrail Investments' Scott Olsson. They argue the banks' recent earnings reports, released earlier this month, are "extremely encouraging", while the incoming deluge of dividends is supported by "strong reported earnings." 

But with this good news in the bank (see what I did there?) is there a chance for these giants to fall, given interest rates are at historic lows and the banks' margins likely to come under pressure.

In this thematic episode of Buy Hold Sell, Livewire Markets' James Marlay sits down with Matthew and Scott to discuss some of the successes, surprises, and shortfalls of the Big Four's earnings reports. Plus, they share some of the risks for investors to keep on their radar.  

Note: You can watch, read or listen to the discussion below. This episode was filmed on 12 May 2021.

Edited Transcript

James Marlay: Welcome to Buy Hold Sell, brought to you by Livewire Markets. My name's James Marlay and today, we're talking about the big banks. Most of you own a few, they're are a huge part of the economy and to help me talk about what went wrong and what went right in their earnings, I'm joined by Matthew Haupt from Wilson Asset Management and Scott Olsson from Firetrail. 

Let's get the low down in a sentence. Scott, your view on the bank reports, just one sentence, what's your summary?

Scott Olsson: My summary would be dividends are back, supported by pretty strong reported earnings. But I think the core earnings outlook is still a bit mixed.

James Marlay: That's a long sentence, Matt, if can you give me just one sentence on bank reports, what have you got for me?

Matthew Haupt: All right. Extremely encouraging with more to come.

James Marlay: Let's talk about the more to come. What did you like in the results? That's a pretty positive summation, so what did you like?

Matthew Haupt: Yeah, I think the real positive was around provisioning. All the models are saying release provisions and they're holding them back. So if the economy keeps improving on this trajectory, you're going to see a lot of provisions released, which will give them more tailwinds for the rest of this year.

James Marlay: Okay. It's been a long time since we've used the word tailwinds to describe the banking sector. Scott, do you agree, do you think that things are finally blowing in the favour of the big four?

Scott Olsson: Yeah, I mean, there's definitely a lot more going for the banks now than there was. I think, overall, our view though, is that a lot of those tailwinds are factored into the prices now and one area that's still a source of weakness is on those margins. They had a really good half, but I think the trend from here is downwards, which puts a bit of revenue pressure on the banks still.

James Marlay: We had a shakeup in 2020 with COVID. A lot of businesses had to look inwardly to try and survive and then thrive coming out of that disruption. Out of the big four, knowing what you know now from the reports, is there a bank that you think has done a particularly good job of reshaping itself on the back of the shakeup?

Scott Olsson: Sure. I think it's still in progress, but I think NAB is a business that is positioned really well from our point of view. Ross McEwan has made some good moves, bringing a lot of focus and accountability to the business and I think the balance that they've got between controlling costs and driving revenue opportunities is just about right and that's quite a differentiator across the banks at the moment.

James Marlay: Same question for you, Matt. You look back to how they were prior to the crash and you look at how they came through it. Is there one that stands out as having fared better than the others?

Matthew Haupt: Yeah. I think the clear winner is CBA based on trajectories. You look at their loan growth, you look at the way the business is generating capital, the returns, it's a clear winner. I agree with Scott, I very much like NAB as well, but it's more of a work in progress. But the clear winner of that period for me was CBA.

James Marlay: There's not that much surprising that happens within the banks. They're big, they're boring, they've been around forever. Was there anything that, you speak with the executives, you look through the results, anything that caught your eye and made you sit up?

Matthew Haupt: Yeah. On the negative side, the capital markets income was quite weak and I thought with rates moving everywhere and FX, there'd be some more income on that side. On the positive side, there was really round deposit margin benefits from winding back deposits so that really helped NIMs and shaped some of the results we saw.

James Marlay: Anything that caught your eye, anything that jumped off the page for you?

Scott Olsson: Yeah. It was that cost target from Westpac, that $8 billion number that's down from a $10 billion base so a 20% absolute reduction. If you take into account inflation, it's something higher than that. The banks have shown it's very hard to pull out absolute costs. I think if they do it, it's admirable but I think it's a big target to put out there.

James Marlay: So, that's a question mark next to that number?

Scott Olsson: That's a question mark for me. I think if they achieve it, the revenue outcome will be lower than the market's expecting. It's very hard to do that without revenue consequences.

James Marlay: Okay. Investors are about to get showered with close to $7 billion worth of fully frank dividends. Turn it back 12 months, that was on hold and investors were starving. So are we at the inflexion point for dividends and we've got more in the cannon? 

Scott Olsson: Yeah. It's definitely higher than I was thinking it was going to be six months ago. From here, I actually think it's going to be pretty flat. Obviously, you've had the benefit of provision writebacks in these results, which has helped. Going forward, those will moderate a little, you'll get a little bit of core earnings growth, so I think overall, dividends will stay around that level, which is still kind of 4.5% yield. It's a pretty reasonable yield that they are rolling out. 

James Marlay: So still quite attractive. Matt, I'm going to stay with you on dividends. Pre-crisis, banks were paying out 70%-80%. Now, those power ratios have been dialled right back. Do you think there's more to come on the dividend front or are you with Scott, with dividends flattening out from here?

Scott Olsson: It all depends on your trajectory of the economy. But I think when you look at the capital position of the banks now, they are in an incredibly strong position. So I think you're going to see special buybacks, like Commonwealth Bank, they've got a huge amount of capital - they're sitting at 12.7% with more capital coming in. You've got NAB, who are going to do on market buybacks so the capital management is definitely a theme you're going to see over the next couple of years from the banks.

James Marlay: Now, the banks have been a bedrock of the Australian financial market and the financial sector more broadly. They've proven themselves to have held up really, really well throughout 2020. But with this low-interest rate environment, free money, we have seen a proliferation of new competitors coming into the market. I think, more broadly, as we look at the sector, what sort of risks are you starting to see when you cast your eyes a little bit further outside? Is there anything that's catching your eyes as being speculative and risky?

Matthew Haupt: I guess when you have free money around and compressed credit spreads, you get all these up and comers because the cost of capital is so low, and availability is so high. For me, you're starting to see a few of the neobanks roll over already before we've even had an explosion of a credit cycle or the cost of funding go up. It's an incredibly tough business banking and it's not just about having distribution, it's about having balance sheets with access to capital. So for me, that is an area that is an impending disaster.

James Marlay: Okay, Scott, do you have some risks that you're seeing around the fringes that are making your eyebrows stand up.

Scott Olsson: Yeah. It's not so much a big blowup risk, but it's more of a risk to bank revenue lines outside of that net interest income line. Areas like FX fees and things like that have been ripe to be disrupted for a while now and I think you're just seeing smaller guys come in and do a good job there. It's very hard to see how the banks continue to grow those fee lines because people just don't like to pay fees and they'll find any way they can to get a better deal.

James Marlay: So you see the new competition being a risk for the banks rather than the rest of the sector?

Scott Olsson: That's more just a risk to revenue profile and fees recovering. I think there will be a bit of recovery off the back of activity, but I wouldn't expect a big bounce because there are a lot of guys competing for that pie.

James Marlay: Well, some upbeat news for the banks. They've bounced back out of COVID, dividends are coming your way, but just be cautious after 20% in the calendar year to date, some of the good news might already be baked in.

What bank do you think has come out on top in 2021? And what is the biggest risk facing the banks over the months ahead? 

Let us know what Big Four bank has impressed you since the beginning of the year. Or, if there is a stock in the financial sector that has caught your fancy, let us know in the comments section below. Plus, we would love to know what major risk you think faces the sector over the coming months. 

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