Big four grossly overpriced

Big four bank shares are grossly overpriced prompting shareholders to clamour for crisis-fighting action from bank chief executives.

The big four lenders need to achieve 13 per cent rise in earnings per share to justify current prices, wrote Morgan Stanley analyst, Richard Wiles.

By his calculations, National Australia Bank would need to boost EPS by a 24 per cent, Australia New Zealand Banking Group by 11 per cent, Commonwealth Bank of Australia by 8 per cent and Westpac Banking Corporation by 10 per cent.

On Wiles’ analysis, this would require 11 basis points of margin expansion, flat loan loss rates of 17 basis points and dividend reinvestment program neutralization for the next three dividends.

Moreover, net interest margins would have to rise a collective 2.10 per cent -  up from the 1.99 per cent estimated for full year 2017.

“In our view, such a scenario is plausible, but still unlikely,” he said adding that the 13 per cent upgrade is based on his full year EPS forecasts for the majors.
 

Emerging challenges 
 

“The big four banks are in a fragile equilibrium, but are priced for a solid loan growth, margin expansion, flat loan losses and no further lift in capital requirements. Plus, the global disagreement on Basel IV has delayed the capital build and deferred a decision on dividend sustainability.

“This combination of factors drove modest EPS upgrades during the February reporting season, supporting trading multiples and driving outperformance vs the broader Australian Stock Exchange

But the analyst warned that this fragile equilibrium is at risk of breaking.

“We see a number of challenges on the horizon for Australia banks: deposit margin squeeze continues; further home loan re-pricing risks slowing loan growth; higher debt levels, higher house prices and tighter lending standards increase risks in the housing market; weak income and employment trends weigh on the outlook for the economy and credit quality;

“APRA's new capital rules are due in coming months; ongoing scrutiny of pricing and conduct is likely; and the nation's AAA and the banks' AA credit ratings are
under review.”

Summarizing the lenders’ capital position, Wiles pointed out that ANZ remains the best placed in terms of capital with potential for $4.8 billion of buybacks in 2018-19 even after assuming a 10 per cent target common equity tier one capital ratio and another 3 per cent lift in mortgage risk weights.

In contrast, he said, the other majors face a $9.3 billion capital build with $3.6 billion at CBA, $3.5 billion at Westpac and $2.2 billion at NAB.

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