14 May 2015
- Bank stocks fell sharply last week, but the weakness really began back in early April.
- The banks reported poor results along with an unexpected capital raising by NAB and expectations of capital raisings by the others to follow.
- NAB is raising $5.5bn, with existing investors being offered new shares on a 2 for 25 basis at $28.50. This is a 20% discount relative to the current NAB trading price.
- Stock prices also fell across the yield sensitive sectors due to rising bond yields and better inflation readings in Europe and the US.
- Bank stocks are now more reasonably priced than they were a week ago and should be well supported by yield hungry investors in light of low interest rates and bond yields.
The ‘Big 4’ banks, as they are affectionately known, fell sharply last week as they provided half yearly (ANZ, NAB, WBC) and quarterly (CBA) trading updates.This weakness really begun back in early April, but was exacerbated by the poor results updates from the banks last week.
Commonwealth Bank of Australia (CBA) is off over 12% since early April whilst Westpac (WBC) has fallen over 13%. ANZ is down close to 9% whilst National Australia Bank (NAB) is down over 9%. NAB announced a $5.5bn equity raising whilst WBC will be raising equity by underwriting their dividend reinvestment plan.
Why did it happen?
Since the beginning of the year, yield sensitive sectors and stocks have been on a tear in the face of declining interest rates and falling bond yields, as yield hungry investors have bid up the price of these with little regard for earnings growth and valuations. The Big 4 were up 15% on average in the first quarter of this year, listed property was up circa 9% and bonds were up over 2%.
This trade was assisted by poor US economic data, which pushed expectations for the Fed’s first rate rise out to later this year, and by the launch of quantitative easing in the Eurozone, which pushed European government bonds yields into negative territory. This resulted in a big influx in foreign capital chasing higher yielding Australian dollar assets.
Closer to home, the RBA obliged by cutting the cash rate in February, catching everyone by surprise as February is usually a benign month for policy decisions. This helped propel yield sensitive assets higher.
Since early April, the yield-tide began to turn. The market started to realise that valuations were out of check with expected earnings, and that the US may raise rates earlier than many think (and earlier than is warranted by the available data) in order to “get the ball rolling” and start to reset market expectations on their policy direction (tightening rather than easing).
At home, pressure arose on the banks regarding their exposure to the booming residential housing market, their all-time low provisions for bad and doubtful debts, and the increasing expectation that they would be forced to hold more capital by the regulator in order meet stress tests of their balance sheets in extreme market environments. It was rumoured that the banks had defied an ‘order’ from the regulators (APRA/RBA) to reign in the growth in new investment loans.
This all came to a head this week when the Big 4 (with the exception of ANZ) largely disappointed the market with their result announcements, reporting weaker earnings growth, declining net interest margins and dividend increases below market expectations. NAB announced an equity raising, whilst WBC (partially underwritten, which means they too will be raising equity) and ANZ announced changes to their dividend reinvestment plans.
Why did NAB choose to raise equity?
NAB announced that they will be demerging their UK assets through a listing on the London stock exchange. The UK banking regulator has approved the demerger on the proviso that NAB hold $3.3bn in ‘capital support’. As such, NAB announced a $5.5bn shareholder rights issue, on a 2 for 25 basis, with the remainder of the funds set aside to assist with meeting any changes made by Australian regulators regarding the amount of regulatory capital the banks must hold.
The raising of additional capital adds 8% of shares on issue, will dilute earnings per share by 4%, and will negatively impact return on equity (though this will be offset by the divestment of the UK business). As a result, NAB intends to maintain a second half dividend the same as they paid in the first half.
NAB was in a trading halt following the announcement on Thursday 7th May whilst they undertook the institutional bookbuild of the offer. This was completed on Tuesday 12th May with trading halt lifted thereafter. The stock price didn’t actually fall that much post the lifting of the trading halt as nearly all institutional investors took up their rights. In addition, the accelerated divestment of the UK business and the equity raising were taken positively by the market.
The retail entitlement offer opens 13th May and closes 1st June. The issue price is $28.50 per share, close to a 20% discount on the trading price ($35.49 at time of writing). The dividend yield on the new equity will be a high 7% (or 10% fully franked).
Investors see the demerger (and the expedited timeframe – completed by the end of 2015) of the UK assets as a big positive. This follows the recent listing of NAB’s US assets, and means that NAB will become much more focused on its very strong Australian and NZ businesses. Investors have also taken an early liking to new CEO, Andrew Thorburn, and the decisive moves he’s made since taking over the role.
How has the outlook for the banks changed?
Given the recently announced results, the market has revised down earnings expectations on the Big 4, which has resulted in small adjustments to valuations.
We expect the banking regulator to force the banks to hold more capital in light of recent rhetoric and the Murray Review. Barring any major and unexpected changes to regulations, the pull back in share prices of the Big 4 now means they look much more reasonably priced than they did earlier in the year. In addition, the banks will be unlikely to pass on the full amount of any further rate cuts by the RBA as they did following the most recent RBA cut (only ANZ passed on the full cut) thus helping the bottom line.
Given we expect interest rates and bond yields to remain lower for much longer, higher dividend paying stocks will continue to be well supported by the market, so long as the dividend is sustainable and able to grow over time.
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