The banking sector is under pressure this month as many have gone ex-dividend and as the global economic turmoil from trade war threats drag on investor sentiment.
The question is whether anything has fundamentally changed now that the big four banks have given earnings updates this month and what are the key takeaways for investors.
The National Australia Bank Ltd. (ASX: NAB) share price and Australia and New Zealand Banking Group (ASX: ANZ) share price have shed close to 5% each since the start of May, while the Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) share prices have fallen a little over 3% each.
Bank stocks facing near-term pressure
In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is down by 1% and the banks are unlikely to bouncing anytime soon given that May and June is typically a weak period for equities and three of the four big banks have just shed their dividend entitlements.
Morgan Stanley has retained its negative stance on the sector in its latest report on the sector aptly titled "Paradise Lost".
"Operating trends were weaker than expected in reporting season, with earnings (ex remediation) missing our estimates by an average of ~2% across the four major banks," said the broker.
"Consensus lacks conviction, with ~50% of analyst ratings being 'Equal-weight'. However, our price targets imply an average of ~7% downside from current prices on an ex-dividend basis."
Key findings from the reporting season
The broker has also highlighted 10 conclusions from the bank reporting season to go with its downbeat outlook for the sector. These are:
- Banks re-rated on rate cut expectations: The broker noted the banks have outperformed in April and thinks that talk of a rate cut here was fuelling the rally. However, it noted that banks often outperform ahead of a rate cut and underperform after the fact.
- Low expectations, but more downgrades: The bar was set low ahead of the reporting season but that wasn't enough to stop Morgan Stanley from downgrading earnings forecasts for the sector.
- Lower loan growth: Credit growth is still weak and the broker sees downside risks to its low expectations of under 2% growth.
- Margins still falling: Net interest margins are under pressure and while they may stabilise in 2HFY19, they could fall again in FY20.
- Pressure on fees in retail banking and wealth management: This is a key of earnings risk for the sector and the reporting season showed that the headwinds are growing.
- "Flat costs" is now a minimum requirement: The only way for banks to lift earnings is to cut costs. Those that can't (or at least hold expenses at current levels) could get punished by investors.
- Remediation costs are still rising: CBA's recent $714 million provision says it all. This will be an ongoing issue for the sector.
- Credit quality is sound but weaker: There are signs that delinquencies are rising. While this isn't a cause for concern yet, things are likely to get worse before they get better.
- 5% is not "unquestionably" strong: APRA uses the 10.5% level (for the CET1 capital ratio) as a benchmark for banks to be considered unquestionably strong. The big four meet this requirement, but just (with ANZ the possible exception). This means they are at risk of falling under given the challenging near-term operating environment.
- Dividend cuts make sense: NAB is the only one in the group that has cut its dividend recently but we may see more dividend cuts in the sector given the challenges outlined above.
