Banking sector - Why the recent underperformance?
29 May 2015
By Shadforth Financial Group
The Australian banking sector has come under selling pressure recently, recording its sharpest retracement versus the S&P/ASX 200 Index since the global financial crisis. The weakness comes after the release of half year results from all the major banks except the Commonwealth Bank, which provided a third quarter trading update.
Weakness can be attributed to a number of factors, including:
- increasing capital requirements that dilutes return on equity
- softer net income margins due to increasing competition
- rising bond yields which can alter relative valuations
- concerns over rising house prices on the east coast
- a view that the provisioning cycle is about to reverse after years of declines
- the probability that payout ratios may restrict dividend growth
- cost growth in some cases exceeding revenue growth.
The above factors cast a cloud over near term earnings growth rates and contributed to an average 0.7% fall in cash earnings for the half, with return on equity falling by an average 0.5%.
Investors appear concerned that increased competition will place continued pressure on net interest margins. This challenging outlook sees market estimates of 3% earnings per share growth for the banking sector in fiscal 2016, compared to 6% for the total market.
The major banks' capital positions and future capital raising needs have again come under the microscope, highlighted by the record $5.5 billion capital raising from National Australia Bank to boost its capital levels before the demerging of its UK business and Westpac's $2billion raising via the underwriting of its dividend reinvestment plan (DRP). The market may be getting nervous that these raisings signal the start of further recapitalisation by the major banks, diluting shareholder returns. The flexibility provided by DRPs means it is unlikely that we will see a repeat of the 2008 capital raisings.
Australian Prudential Regulation Authority (APRA) chair Wayne Byres recently backed banks in taking early action to raise their capital levels. Mr Byres commented that the regulator 'fully' supported the first recommendation of the financial system inquiry: that banks be 'unquestionably strong.'
While rising bond yields have had an impact on bank share prices, they only explain part of the underperformance. The table below compares the performance of the financial sector versus other traditional yield sensitive sectors since 15 April 2015.
As you can see, the financial sector has significantly underperformed traditional yield sensitive sectors. Rising bond yields therefore only explain part of the weakness.
Whilst the banking sector has earnings headwinds going forward, valuation support and the ongoing 'chase for yield' is likely to provide share price support.