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Mixed picture on bank shares

23 Jul 2021 1 month(s) ago

Mortgage volumes are booming. Will this save bank shares?

What is the future of bank shares? According to a note from Citi, price earnings ratios (known as P/Es, or the price of the share versus the earnings per share) are high historically. This might point to weakness. “After a strong rally over the past 12 months, the banks are looking expensive in P/E terms as they trade well above 5 & 10 year averages.”

“Can mortgage revenues be the saviour ... again?" Citi asks. The broker says investors looking to tap into what is expected to be a cyclical recovery may think they will get less mileage out of bank stocks. 

"The high multiple but lower sensitivity to a recovery in volumes may present downside risk to current valuations. However the sector’s relative prospects remain more positive. Against the broader ASX 200, the sector is still trading on a ~33% discount, well below the ~20% that it used to print prior to 5 years of bad news and falling rates post 2015.”

Citi says mortgage growth remaina the only bright spot of credit growth. “Consequently, we continue to prefer the retail banks over the business banks. What happens when the economy normalises and bad debts are written back? Will the sector have enough revenue growth to justify their current valuations?”

Citi’s note reckons this cycle is expected to generate lower revenue growth compared to the FY14-17 residential property bull market. This is a comparison of CBA's 2014-17 history versus 2020-2023:

 

“One of the most obvious points of differentiation is the varying levels of activity between various cohorts in the market. Going back to 2014-17, activity was very much led by investors who were producing double digit credit growth, marginalising other cohorts with less firepower.

“However, this time around, it has been a market that has been driven by ‘quality’, as owner occupier upgraders and First Home Buyers have dominated flow. While we expect investors will come back into the market, arguably it will be a structurally lower rate of growth given depressed rental yields and responsible lending changes.

“Gone are the days of the news stories of the 30 year-old tradie/’property guru’ who’s amassed a ten property portfolio in 3 years! Looking at FY20-23E, we expect volume growth to be below last cycle for those very reasons.

Citi says net interest margins will be squeezed more, reducing the revenue that banks get even as mortgage volumes increase. “However, we also expect a disconnect between volume growth and revenue growth which wasn’t present in the last cycle. Taking CBA (Commonwealth Bank) as an example given their disclosures, we expect revenue growth of ~5% against volume growth of ~7%.”

Citi says in 2014-17 interest margins expanded at the same time as the volume of mortgages increased. That is not likely to be repeated, partly because interest margins tend to go up as the base interest rate falls. With the Reserve Bank’s base rate at 0.1%, there is nowhere left to go down, so the margins get on their loans will not improve.

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