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You know the fairy tale about the fabled Emperor scammed by a tailor who made him believe he was weaving an elegant robe when in fact he was wearing nothing of the sort. During a parade to show his subjects his splendid new fittings, a small child shouts out the truth – the emperor has no clothes.

Australia’s big banks are in the news again. Touted as the world’s safest banks, investors have flocked to the big four and to a lesser extent their regional cousins for outstanding dividend yields. But have investors been fooled? Did the banks’ impressive profitability and high dividend payouts translate into outstanding shareholder return over time? 

The following table includes the yearly share price performance of the big four plus two regionals:

 

Bank

Code

Mkt Cap

Share Price

52 Wk Hi

52 Wk Lo

% Move

Bendigo-Adelaide Bank

BEN

$3.2b

$7.9

$9.64

$6.82

-16%

Bank of Queensland

BOQ

$2.28b

$7.46

$8.49

$6.13

-8%

Australia & New Zealand Banking Corporation

ANZ

$68b

$25.33

$27.63

$18.6

+18%

National Australia Bank

NAB

$54.46b

$25.03

$27.13

$21.52

0

Commonwealth Bank of Australia

CBA

$90.96b

$57.27

$58.05

$45.39

+18%

Westpac Banking

WBC

$76.26b

$25.14

$26.12

$19.29

+18%

 

Despite all the bad news over the past year – credit agency downgrades over external funding concerns, a deteriorating property market, a dramatic slowdown in the commodities boom and challenging economic conditions throughout Australia – the share prices of the big four have stayed firm. Investors can’t resist the clarion call of high dividend yields, or so it would seem.  

 

But how much have the shareholders benefited? On a one year basis, they’ve performed nicely, but let’s look at 5 year returns.

 

The following table examines 1 Year and 5 Year average total shareholder returns for the big four, plus one-year dividend yield and the percentage increase in net profit over 5 Years:

 

Code

1 Year Dividend Yield

1 Year Average Annual Shareholder Return

5 Year Average Annual Shareholder Return

5 Year Net Profit Change

ANZ

5.7%

35.4%

4.2%

+72%

CBA

5.09%

28.6%

5.4%

+49%

NAB

7.19%

15.2%

-1.6%

-9%

WBC

6.4%

27.2%

3.6%

+82%

 Only Commonwealth Bank delivered annual total returns (stock price appreciation plus dividends) that matched this year’s yield.   It appears from the data that the perception of generous returns from buying shares in the big banks has not proven true over a five-year period. Over that same period, shareholders of service provider Monadelphous Group (MND) were rewarded with a 15.2% average annual rate of return; shareholders of Ramsey Health Care (RHC) saw a 20% return, and shareholders of Iluka Resources Ltd (ILU) scooped a 22% return.  

Indeed, record profits generated by the big banks did not find its way into investors’ pockets. Record profits yielded no more than 3 to 6% return to investors.

 

So what happens when bank profitability shrinks?

Bank profitability was largely driven by a booming home mortgage market alongside loans to support miners raking in cash from the commodities boom.  Back in July 2009, the big four accounted for almost 100% of the $7 billion dollars in new mortgages written, according to the Australian Prudential Regulation Authority (APRA). Prior to the onset of the GFC the big four had 60% of the new mortgage market and today they boast a significant 86% market share, APRA shows.

However, even 100% of a dwindling market spells trouble for future profit growth. Here are four reasons why banks are becoming riskier:

– Housing market is tightening

– Slowing credit growth

– External funding

– RBA rate cuts

Housing

 

No matter how much the property industry tries to spin a bullish angle, the property figures coming out are grim. 

 

New home sales fell to an 18 year low in September, according to the Housing Industry Association (HIA). HIA chief economist Harley Dale noted a “dire lack of confidence towards housing”.

“Despite interest rate cuts, there is a very clear lack of demand on the part of households, a very clear lack of appetite for going from a tyre-kicker to actively building a home,” Dale said.

 

To make matters worse, existing homeowners are struggling to meet mortgage payments on properties – with a growing number resorting to tapping super funds to keep current with payments. The Sydney Morning Herald reported  a 12% yearly increase in the number of people qualifying for Federal Government approval to withdraw funds from super.  A notice of foreclosure is one of the requirements.  The average payment of $15,000 totaled a record $100 million.  Between 2011 and 2012 there was a 25% increase in withdrawal requests.  

Mortgage loans appear as assets on bank balance sheets because of the interest payments they earn. Lurking in the shadows is the prospect of increasing loan defaults stemming from Australia’s previously unknown sub-prime lending practices.  In its annual earnings release, National Australia Bank shocked the market with a 44% increase in provisions for bad debts, a total of $2.6 billion.  While the lion’s share of the increase is attributable to NAB’s United Kingdom operations, the bank’s CFO reported an increase of $159 million in bad debts from loans to small and medium-sized businesses in Australia.  

Unemployment ran from 5.1% in August to 5.4% in September, adding to bad debt worries should economic conditions continue to deteriorate.

Credit Growth

Without consumers and businesses relying on bank credit in any form, the asset base of the bank is threatened. Economist Steve Keen’s Debtwatch tells us the post GFC annual private credit growth stands at just 3.5%. Here’s a chart showing the drop since the GFC:

 

 

A critical subset of private credit growth is housing credit – which is the end of town where the big four make the big profits. The following chart is rather telling:

 

 

Funding and RBA Rate Cuts

In order to make loans, banks need capital – which comes from customer deposits and the sale of investment securities. Foreign investors have provided the big four with ample funding due to higher interest rates here as opposed to rates near zero throughout much of the rest of the industrialised world.  With a resources boom and a housing market in decline, our economy could face a tough road ahead, and foreign investors are watching closely.  

Financial experts predict more RBA rate cuts down the line to boost the economy.  The big four to date have not passed the rate cuts through to standard variable loan interest rates, currently at 6.22%, while the cash rate stands at 3.25%.

 

Although rate cuts may boost the economy, for profitability sake banks prefer not to lower rates. If our rates fall low enough, foreign investors may begin to look elsewhere for places to park their cash.

Arguably this is not happening now, and won’t happen over the short term.  We live in a “glass half full/half empty” economy where there is ample opinion on both sides of the issue; will our economy recover or stagnate? 

 

However, even in a best case scenario, our big banks will struggle to simply maintain profit levels of the past decade. 

 

 >> Click here to read other articles from this week’s newsletter

 

 

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