Banks swing back into favour

Published in the Australian Banking and Finance Magazine, August 2009

After traversing through the global financial crisis and the economic downturn which has followed. Australian banks are being seen in a more positive light.

Recent coverage of the Australian banking sector has been positive.

Citigroup raised its ratings on our four largest banks to "buy" from "hold" while Goldman Sachs JBWere upgraded its recommendations on National Australia Bank, ANZ and Westpac.

"With evidence continuing to mount, we now believe that the economic downturn in Australia will be less severe than we had previously anticipated. Given this, we are becoming more optimistic about the outlook for the major Australian banks," Citi analyst Craig Williams said in a note to clients late last month.

Joe Youssef, head of Sydney private clients at Austock Securities, told AB+F that sentiment for the sector was improving as the stock market showed signs of a recovery.

"I've been very bullish on the banking sector and there are a number of reasons why," he said.

"If we look at the broader market, at its absolute worst it was priced on panic. The market tends to overshoot in both directions and the reason why it overshot on the south side was because panic gripped the market.

"As a result banks were skewed away heavily from their fundamentals.

"There was a big valuation gap with regards to fear and potential further write downs in the banks' balance sheets that were being priced in, and what reality was more.

"With the growing confidence in the corporate sector and with credit spreads actually showing some signs of coming in, we believe there is potential for the banks to surprise on the upside with regards to earning consensus forecasts."

Capital ratios

With ANZ and NAB's recent capital raisings, discussion is turning to the amount of capital banks have raised - is too much, too little or just right?

"The banks are now well capitalised and have enough funds set aside for a worst-case scenario in terms of job losses and bad loans,"

Chris Weston, an institutional dealer at IG Markets, told Bloomberg.

JP Morgan banking analyst Scott Manning, in a research note to clients, said that in the light of ANZ's and National Australia Bank's activity, "investors are now asking the inevitable question of whether Commonwealth and Westpac are next".

"With the last reported Tier 1 position of Commonwealth at 8.33 per cent and Westpac at 8.37 per cent, perception of an imminent `catch up' round of capital raisings to achieve overall sectoral Tier 1 ratios of 9 per cent are emerging."

However, Manning said he didn't think this would be the case, based on JP Morgan's forecasts for both Commonwealth and Westpac's provisioning levels and credit growth, which are viewed as positive.

Youssef said prudential regulator APRA had played its part in ensuring Australia's banks were well capitalised.

"A lot of the capital adequacy and the Tier 1 capital requirements are arguably the most onerous and best in the world," he said.

Consolidation and competition fears

Analyst Dale Gillham, from Wealth Within, said the dominance of the Big Four banks had increased as a result of the wave of consolidation in the sector over the last 18 months.

"Second tier banks are struggling to get funding at the moment," he said.

"I think there is going to be a lot more of the big banks looking to take over some of these second tier banks.”

"The government needs to get out and support these smaller banks.

"I'm all for our banks getting bigger because they need to compete on world markets but it shouldn't be at the detriment of the second tier banks.”

"From a consumer point of view, competition is vital."

Youssef said moves by banks to abolish or reduce fees for customers was a strategy to ease customers' fears over the power and dominance of the banks.”

"It is going to have an adverse impact on their earnings but at the same time the positive sentiment [towards the banking sector] may counteract that to an extent," he said.

"But the bottom line is that they are earnings juggernauts. They have had a history, irrespective of the economic cycles, of generating pretty decent returns for their shareholder base."

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