Has The Outlook Improved For Banks?
Australia | 10:00 AM  Banks have been in the firing line for some time regarding regulatory issues and concerns over credit provisioning. -Banks should experience resilient returns from SME banking operations  -Yet returns are depressed as major banks are holding excess CET1 capital  -Capital management may still be on offer from all major banks  -Macro prudential policies likely first step for regulators to cool housing market    By Eva Brocklehurst  Australia's banking sector has been facing negative news for some time, provoked by several regulatory slap-downs and concerns over provisioning for the pandemic. Having sampled the small end of small-medium enterprises (SMEs) regarding attitudes towards merchant acquirers and banking partners, JPMorgan concludes there are some positive aspects emerging. In business banking the broker found evidence that this is now a less commoditised relationship compared with retail banking. Businesses have long relationships with their banks and only around one third of those sampled considered lending rates to be the most important factor when choosing a business bank. Only 21% of customers considers it likely they may change their main business bank over the next year. While 50% of this cohort envisaged pricing as the main reason to switch, only half that number would move their loan for a reduction in interest rates of -20 basis points or less. Merchants selected reliability, price and fast clearing as the three most important attributes of the payments system and these have all historically played to Tyro Payments' ((TYR)) advantage, the broker suggests. Only 12% of the sample switched providers in the last three years. What did surprise JPMorgan was that 35% of the sample had experienced an increase in the cost of card acceptance. The opposite was expected to occur as a result of increasing competition and the broker suspects payments innovations such as me&u possible contributors. Given the implications of the survey, JPMorgan suspects banks should experience resilient returns in their SME bank operations. National Australia Bank ((NAB)) is favoured in this regard as it has the greatest exposure to SMEs. The business banking division accounts for more than 40% of its earnings. Expectations of resilient returns from SMEs also supports the rationale for Commonwealth Bank ((CBA)) to push into this area. JPMorgan envisages a risk that over time, ANZ Bank ((ANZ)) and Westpac ((WBC)) will be left behind in this market because of a lack of scale and technological advantage. Morgans prefers ANZ and Westpac, believing these offer the most compelling value of the major banks in terms of the return on tangible equity (ROTE). The broker emphasises its focus is on tangible equity rather than cash returns on equity (ROE). ROTE at present is depressed because the major banks are each holding excess CET1 capital. Morgans is more optimistic that net interest margins can be supported by further drawdowns on the Reserve Bank's term funding facility, also noting several major banks have recently increased interest rates on some fixed-rate home loans. Again, in contrast to other market observers, Morgans expects customer deposit growth will be stronger than credit growth over the next year. In sum, the broker believes the potential for absolute cost reduction in the sector over the medium term is real and this should support returns. Going into the latest coronavirus-related lockdowns, Morgans assesses all four major banks have conservative collective provisioning levels. While there is potential for some releases, with lockdowns still playing a part, this is likely to be delayed  The major banks are expected to maintain their current levels of collective provisioning for credit risk-weighted assets yet the broker continues to believe consensus is too pessimistic regarding the cost of risk. The cost of risk should remain low for the next couple of years if there is no significant increase in new impaired assets. Furthermore, in the event of extended lockdowns, Morgans suspects fiscal policy support and monetary policy measures will be dialled up again and underpin asset quality. Capital Management  Westpac's pay-out ratio guidance of 60-65% over the medium term is conservative. Morgans asserts the bank can sustain a ratio of 65-70% over the medium term and neutralise the dividend reinvestment plans. ANZ remains Morgans' preferred major bank on a value basis, and while CBA's underlying ROTE may be superior to its peers, current multiples are considered stretched. Investor interest appears mainly focused on capital management potential at CBA but Morgans considers this is a probability for each of the major banks and initiatives could be announced as early as the FY21 results. Nevertheless, the broker would not be surprised if NAB waits for the resolution of the AUSTRAC issue before embarking on capital management. Admittedly, the reinstatement of lockdowns is clouding the outlook for asset quality and Morgans acknowledges other banks may also choose to push back the timing of pay-outs.