Banks

We’ve just gone through the bank results season (plus the CBA quarterly, which isn’t shown in the below mix of graphs).

Some observations. The banks are extraordinarily well capitalised, having doubled or near trebled the equity cushion. Consider perhaps that they were horribly undercapitalised during the GFC, but that counterfactual (a US styled housing meltdown) didn’t happen, and thus our banks squeaked through.

The funding ratios, liquidity coverage ratios, are all strong and I won’t drain your attention with them. But, suffice to say, “fortress” balance sheets come at a cost, the banking sector ROE has broadly halved. ROE is the primary determinant of price-book multiples, and thus the transition from ’08 to ’24 has weighed heavily on bank returns.

Impairments remain very low, and the banks are well provisioned.

Arrears are climbing, though, and the near universal expectation from mgmt is that arrears will continue to rise as the economy slows and the impact of higher rates bites.

The only variable that really matters to bank solvency is what you can sell the underlying collateral for. As long as house prices don’t retreat, things will (likely) be fine. Our view is that house prices will fall, but it isn’t a problem for today, or even tomorrow. We should be able to see it coming.

NIM’s continue to reflect the highly competitive environment, with pressures evident across most banks. CBA and WBC commentary suggests that some of this pressure has abated, with a degree of rationality returning (i.e., not pricing loans below the cost of capital). However, we’ve also been able to find the exact opposite kind of commentary, and thus I think you’ll have to see it in the numbers before you can become too confident.

The “glass half full” view; the banks aren’t growing. Revenues, net interest income, have traded sideways for a while. Returns have dropped. Costs are proving very difficult to manage/control, and housing affordability crimps future loan growth.

Valuations are elevated, the banks have been on something of tear since October.

…but the main valuation issue we have is shown below. Compared to almost any other banking geograpy on the planet, Aussie banks are very fully priced.

And so, we remain around 5% UW the banks; we like the yields, we like the balance sheet strength, but we don’t love the valuations and it’s not clear that the competitive environment will permit markedly better NIM’s anytime soon, even if things have moderated a touch recently at the margin.

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