1 00:00:05,700 --> 00:00:08,010 Sean Aylmer: Welcome to the Fear and Greed business interview. I'm Sean 2 00:00:08,250 --> 00:00:11,190 Sean Aylmer: Aylmer. The big four banks have had a pretty remarkable 3 00:00:11,190 --> 00:00:13,860 Sean Aylmer: run lately. They've been led of course by the Commonwealth 4 00:00:13,860 --> 00:00:17,039 Sean Aylmer: Bank, which has hit record highs. National Australia Bank last 5 00:00:17,039 --> 00:00:19,860 Sean Aylmer: week hit nine- year highs. Many analysts say the banks 6 00:00:19,860 --> 00:00:23,099 Sean Aylmer: are now too expensive, so why then are investors still 7 00:00:23,100 --> 00:00:26,520 Sean Aylmer: interested? Remember, this is general information only and you should 8 00:00:26,520 --> 00:00:30,059 Sean Aylmer: always seek professional advice before making any investment decisions. Nathan 9 00:00:30,059 --> 00:00:33,449 Sean Aylmer: Zaia is Morningstar's bank analyst. Nathan, welcome back to Fear 10 00:00:33,450 --> 00:00:33,930 Sean Aylmer: and Greed. 11 00:00:34,409 --> 00:00:35,098 Nathan Zaia: Thanks for having me. 12 00:00:35,609 --> 00:00:38,490 Sean Aylmer: Why are they running so hard? Simple as that, Nathan. 13 00:00:38,490 --> 00:00:41,610 Sean Aylmer: When so many professional analysts like yourself, I don't know 14 00:00:41,610 --> 00:00:44,010 Sean Aylmer: what you've got on them, but many of your brethren 15 00:00:44,010 --> 00:00:46,409 Sean Aylmer: are saying they're a bit expensive. Why are the banks 16 00:00:46,409 --> 00:00:47,249 Sean Aylmer: doing so well? 17 00:00:48,030 --> 00:00:50,369 Nathan Zaia: Yeah, I think the market had been pricing in a 18 00:00:50,370 --> 00:00:54,029 Nathan Zaia: continuation of margins being squeezed, and then you would also 19 00:00:54,029 --> 00:00:57,810 Nathan Zaia: have bad debts jumping at the same time. Both of 20 00:00:57,810 --> 00:01:00,930 Nathan Zaia: those factors not good for bank profits, but the bank 21 00:01:00,930 --> 00:01:04,919 Nathan Zaia: results we had last week indicated things maybe aren't as 22 00:01:04,920 --> 00:01:09,749 Nathan Zaia: bad as many had feared. They showed margin pressure was 23 00:01:09,750 --> 00:01:12,929 Nathan Zaia: continuing, but did seem to be moderating. We've seen some 24 00:01:12,930 --> 00:01:17,220 Nathan Zaia: repricing on home loans, on deposits, some signs that the 25 00:01:17,220 --> 00:01:19,950 Nathan Zaia: banks were acting a little bit more rationally, because we 26 00:01:19,950 --> 00:01:23,940 Nathan Zaia: have seen the returns on mortgages in particular. They've been 27 00:01:23,940 --> 00:01:27,809 Nathan Zaia: squeezed down to levels that we don't think are sustainable. I 28 00:01:27,809 --> 00:01:30,810 Nathan Zaia: think we've seen banks sort of rerate on the back 29 00:01:30,810 --> 00:01:33,750 Nathan Zaia: of that and then it brings us to now, where 30 00:01:34,080 --> 00:01:37,350 Nathan Zaia: many people are saying the banks are too expensive, and 31 00:01:37,350 --> 00:01:39,869 Nathan Zaia: I think that comes down to what is your outlook 32 00:01:39,870 --> 00:01:45,000 Nathan Zaia: for the banks. I think most are still thinking margins, 33 00:01:45,179 --> 00:01:49,980 Nathan Zaia: maybe the rate at which they're contracting stops, but I don't think 34 00:01:49,980 --> 00:01:54,480 Nathan Zaia: most are still thinking they will get squeezed further, whereas 35 00:01:54,480 --> 00:01:57,060 Nathan Zaia: we have a slightly different view. We think they will 36 00:01:57,360 --> 00:02:00,150 Nathan Zaia: actually flat line to even pick up a little bit. 37 00:02:00,750 --> 00:02:03,839 Nathan Zaia: If you have that and bad debt's rising, but not 38 00:02:04,680 --> 00:02:08,460 Nathan Zaia: anywhere out of the norm of historical averages, we still 39 00:02:08,460 --> 00:02:13,800 Nathan Zaia: see potential for earnings growth, modest earnings growth from this 40 00:02:13,800 --> 00:02:17,429 Nathan Zaia: point on. I think, I guess why, if you look 41 00:02:17,429 --> 00:02:20,340 Nathan Zaia: at share prices today, some would say they're expensive if 42 00:02:20,340 --> 00:02:23,309 Nathan Zaia: they have that more pessimistic view on the outlook for banks. 43 00:02:24,209 --> 00:02:26,700 Sean Aylmer: I remember a couple of years ago talking to an 44 00:02:26,700 --> 00:02:29,370 Sean Aylmer: analyst who is sort of saying, " Well, it's hard to 45 00:02:29,370 --> 00:02:32,010 Sean Aylmer: see where growth comes from banks." There'll be a lot 46 00:02:32,010 --> 00:02:34,530 Sean Aylmer: of cost- cutting, and they'll go through that process. I 47 00:02:34,530 --> 00:02:37,830 Sean Aylmer: suppose then Covid hit and we've emerged from that and 48 00:02:37,830 --> 00:02:40,679 Sean Aylmer: you've got a lot more volatility in other sectors, resources 49 00:02:40,680 --> 00:02:43,050 Sean Aylmer: being an obvious one. Energy prices go through the roof, 50 00:02:43,050 --> 00:02:46,680 Sean Aylmer: they come off on oil prices, other commodity, lithium, nickel, 51 00:02:46,680 --> 00:02:48,780 Sean Aylmer: those sorts of things. But banks have kind of been 52 00:02:48,780 --> 00:02:53,940 Sean Aylmer: this really steadfast sector for investors it seems. 53 00:02:54,570 --> 00:02:58,139 Nathan Zaia: Yeah, I think if you look at banks, it's hard 54 00:02:58,139 --> 00:03:02,400 Nathan Zaia: to get excited and see them as growth stocks or a 55 00:03:02,400 --> 00:03:05,700 Nathan Zaia: fantastic outlook, but if you just think about if they 56 00:03:05,700 --> 00:03:09,750 Nathan Zaia: can get modest credit growth grow in line with systems, 57 00:03:09,750 --> 00:03:13,020 Nathan Zaia: say three to 4% if their margins hold up or 58 00:03:13,830 --> 00:03:17,699 Nathan Zaia: move slightly higher, and you can maintain your cost growth 59 00:03:18,180 --> 00:03:21,870 Nathan Zaia: to the 2- 3% range, which has been very challenging 60 00:03:22,230 --> 00:03:25,530 Nathan Zaia: in the last few years. But I think one thing 61 00:03:25,530 --> 00:03:29,040 Nathan Zaia: that might be overlooked is some of these banks, I 62 00:03:29,040 --> 00:03:31,859 Nathan Zaia: think they are spending too much money, whether it's running 63 00:03:31,860 --> 00:03:35,969 Nathan Zaia: multiple systems that you don't need to be at one point. 64 00:03:36,570 --> 00:03:36,630 Sean Aylmer: Yeah. 65 00:03:36,630 --> 00:03:39,000 Nathan Zaia: I think at some point when they can bring down 66 00:03:39,000 --> 00:03:41,970 Nathan Zaia: that cost base to a more sustainable level and keep 67 00:03:41,970 --> 00:03:44,760 Nathan Zaia: cost growth low, you might be able to eke out 68 00:03:44,760 --> 00:03:47,850 Nathan Zaia: a few percent profit growth and EPS growth a year. 69 00:03:48,719 --> 00:03:51,990 Nathan Zaia: If they're priced for that and they're well capitalized and they 70 00:03:52,080 --> 00:03:56,370 Nathan Zaia: can pay a dividend, then P of 12 and yield of close 71 00:03:56,370 --> 00:04:00,000 Nathan Zaia: to six doesn't look that expensive to me. I mean, 72 00:04:00,000 --> 00:04:02,790 Nathan Zaia: there are differences between them. We're talking generally about the 73 00:04:02,790 --> 00:04:07,799 Nathan Zaia: major banks, but yes, CBA doesn't fit into that category 74 00:04:07,799 --> 00:04:09,000 Nathan Zaia: I just described. 75 00:04:09,509 --> 00:04:12,240 Sean Aylmer: Yeah, I mean Commonwealth Banks at an all time high 76 00:04:12,240 --> 00:04:16,020 Sean Aylmer: or thereabouts. Can it go further? What's the story with 77 00:04:16,020 --> 00:04:16,740 Sean Aylmer: Commonwealth Bank? 78 00:04:17,430 --> 00:04:20,520 Nathan Zaia: It's a good question. We have a fair value of $90. 79 00:04:20,520 --> 00:04:24,809 Sean Aylmer: Right, and it's what, 115 or 20 or something? 80 00:04:25,650 --> 00:04:29,879 Nathan Zaia: 15, yeah. North of 120, yeah. Yeah, we think it's pretty expensive. On our numbers, 81 00:04:29,879 --> 00:04:33,000 Nathan Zaia: it's a P north of 20, dividend yield under three. 82 00:04:33,510 --> 00:04:36,210 Nathan Zaia: Yeah, I don't think much has to go wrong for 83 00:04:36,210 --> 00:04:40,169 Nathan Zaia: investors to question whether those sorts of multiples are justified, 84 00:04:40,170 --> 00:04:43,229 Nathan Zaia: but there's been a lot of speculation about why is 85 00:04:43,980 --> 00:04:47,219 Nathan Zaia: it offshore investors looking for a safe haven, picking the 86 00:04:47,219 --> 00:04:51,719 Nathan Zaia: best bank retail investors in Australia, just not wanting to 87 00:04:51,720 --> 00:04:54,900 Nathan Zaia: sell. Again, if you want exposure to a bank, you 88 00:04:54,900 --> 00:04:56,640 Nathan Zaia: just buy the best one. Yeah. 89 00:04:56,640 --> 00:04:56,700 Sean Aylmer: Yeah. 90 00:04:56,700 --> 00:04:57,210 Nathan Zaia: I mean, it seems to have been working. 91 00:04:57,570 --> 00:04:57,750 Sean Aylmer: Yep. 92 00:05:00,089 --> 00:05:03,178 Nathan Zaia: But yeah, we definitely do think it's expensive. Even in 93 00:05:03,178 --> 00:05:06,990 Nathan Zaia: our fair value, we're assuming CPA begins taking share again 94 00:05:07,050 --> 00:05:09,750 Nathan Zaia: in business and home lending, which is a turnaround from 95 00:05:09,750 --> 00:05:14,520 Nathan Zaia: right now. We think their margins improve and that's again, 96 00:05:14,520 --> 00:05:16,440 Nathan Zaia: a turnaround from current trends. 97 00:05:16,800 --> 00:05:17,580 Sean Aylmer: Yeah, yep. 98 00:05:17,580 --> 00:05:21,450 Nathan Zaia: Costs rising very modestly, bad debts remaining close to long- 99 00:05:21,450 --> 00:05:24,960 Nathan Zaia: term averages, and we get an ROE of 15% in a 100 00:05:24,960 --> 00:05:27,960 Nathan Zaia: few years, which is a positive outlook for the bank. 101 00:05:27,960 --> 00:05:31,740 Nathan Zaia: But yeah, it's still an outlier. If you look at 102 00:05:32,160 --> 00:05:35,400 Nathan Zaia: Royal Bank of Canada, similar ROE to CBA priced the 103 00:05:35,400 --> 00:05:38,488 Nathan Zaia: book of 1. 8 times. CBA priced the book on 104 00:05:38,490 --> 00:05:40,409 Nathan Zaia: our numbers is 2. 8 times. 105 00:05:40,409 --> 00:05:40,469 Sean Aylmer: Wow. 106 00:05:41,730 --> 00:05:44,310 Nathan Zaia: It's a huge difference and JP Morgan in the US, 107 00:05:44,310 --> 00:05:49,380 Nathan Zaia: similar sort of multiple under two times. Yeah, it's an 108 00:05:49,380 --> 00:05:52,680 Nathan Zaia: outlier in Australia and it's an outlier globally as well. 109 00:05:53,610 --> 00:05:55,140 Nathan Zaia: Yeah, hard to justify. 110 00:05:55,950 --> 00:05:57,839 Sean Aylmer: Stay with me, Nathan. We'll be back in a minute. 111 00:06:04,440 --> 00:06:08,520 Sean Aylmer: My guest today is Nathan Zaia, senior equity analyst at 112 00:06:08,520 --> 00:06:12,178 Sean Aylmer: Morningstar. You kind of hinted at the weight of overseas 113 00:06:12,178 --> 00:06:16,289 Sean Aylmer: money, so there's been theories unproven that rather than invest 114 00:06:16,289 --> 00:06:18,810 Sean Aylmer: in China, you throw it into Commonwealth Bank is one. 115 00:06:18,869 --> 00:06:22,110 Sean Aylmer: What about the idea that because we have so much 116 00:06:22,110 --> 00:06:25,590 Sean Aylmer: mandated superannuation and people want to invest in Aussie shares 117 00:06:25,950 --> 00:06:29,130 Sean Aylmer: and there's just not a huge amount of stuff to 118 00:06:29,130 --> 00:06:31,859 Sean Aylmer: invest in, that helps the banks. I think the financials 119 00:06:31,860 --> 00:06:35,490 Sean Aylmer: are what, 20-25% of the index? They kind of have 120 00:06:35,490 --> 00:06:39,900 Sean Aylmer: this natural floor almost, which is the superannuation system. Is there anything 121 00:06:39,900 --> 00:06:40,320 Sean Aylmer: in that? 122 00:06:40,950 --> 00:06:45,029 Nathan Zaia: Yeah, I mean, there can be, so if the largest 123 00:06:45,120 --> 00:06:48,749 Nathan Zaia: super fund has a preference for one bank or two 124 00:06:48,750 --> 00:06:52,289 Nathan Zaia: banks over the others, or it's picking sectors, yeah. That 125 00:06:52,289 --> 00:06:55,260 Nathan Zaia: is a lot of money that can have an effect. 126 00:06:55,830 --> 00:07:00,779 Nathan Zaia: But I think that trend of the superfunds, AUM growing 127 00:07:00,779 --> 00:07:04,529 Nathan Zaia: substantially and limited options on the ASIX, it probably lifts 128 00:07:05,070 --> 00:07:06,000 Nathan Zaia: the whole market. 129 00:07:06,178 --> 00:07:06,238 Sean Aylmer: Yeah. 130 00:07:06,240 --> 00:07:09,510 Nathan Zaia: Maybe the whole multiples on what we're used to on 131 00:07:09,510 --> 00:07:14,130 Nathan Zaia: the ASIX 200 just naturally get higher and higher over time 132 00:07:14,130 --> 00:07:16,590 Nathan Zaia: as well. That's something we have to get used to, 133 00:07:16,950 --> 00:07:20,309 Nathan Zaia: but even in that, I think there will be opportunities between 134 00:07:20,309 --> 00:07:24,870 Nathan Zaia: sectors and different sectors. Yeah, I still think stock picking 135 00:07:25,559 --> 00:07:29,789 Nathan Zaia: can still work, even though I guess that super money 136 00:07:29,850 --> 00:07:30,990 Nathan Zaia: will lift all boats. 137 00:07:31,110 --> 00:07:33,810 Sean Aylmer: Yeah. You mentioned dividends, and I think you said Commonwealth Bank is 138 00:07:34,050 --> 00:07:38,610 Sean Aylmer: yielding 3%, others are yielding 6%. Do you think that 139 00:07:38,610 --> 00:07:41,009 Sean Aylmer: the banks can keep... I mean, what's the outlook for 140 00:07:41,010 --> 00:07:43,650 Sean Aylmer: dividends? We've sort of seen a bunch of buybacks as 141 00:07:43,650 --> 00:07:46,889 Sean Aylmer: well in other sectors particularly. I mean, what's the outlook 142 00:07:46,889 --> 00:07:48,089 Sean Aylmer: for buybacks and dividends? 143 00:07:48,570 --> 00:07:52,530 Nathan Zaia: Yeah, I think on our numbers, the CBA yield, it's just under 4%. 144 00:07:53,370 --> 00:07:53,580 Sean Aylmer: Right. 145 00:07:53,580 --> 00:07:56,640 Nathan Zaia: Some of the other banks just under six. But yeah, 146 00:07:57,510 --> 00:08:00,090 Nathan Zaia: I'm still positive on the outlook for dividends. I think 147 00:08:00,450 --> 00:08:04,079 Nathan Zaia: EPS comes down this year, say 5%, but I still 148 00:08:04,080 --> 00:08:07,410 Nathan Zaia: think dividends hold flat or even grown modestly because the 149 00:08:07,410 --> 00:08:11,370 Nathan Zaia: banks are sitting on pretty large surplus capital positions even 150 00:08:11,370 --> 00:08:15,179 Nathan Zaia: after they did that last round of buybacks. Yeah, their 151 00:08:15,179 --> 00:08:19,018 Nathan Zaia: capital surplus, this is above what they target, which I 152 00:08:19,020 --> 00:08:23,729 Nathan Zaia: think is a reasonable buffer over the APPA requirements. They still 153 00:08:23,730 --> 00:08:26,880 Nathan Zaia: have 6 billion between them. I think we'll still get 154 00:08:26,880 --> 00:08:31,380 Nathan Zaia: more buybacks to come. I think dividend growth will remain 155 00:08:31,380 --> 00:08:36,360 Nathan Zaia: modest, and Westpac in particular, they're holding extra capital for 156 00:08:36,360 --> 00:08:42,088 Nathan Zaia: operational issues and that regulatory lift, when that's done, say 157 00:08:42,090 --> 00:08:44,309 Nathan Zaia: next six to 12 months, that could be another one 158 00:08:44,309 --> 00:08:46,290 Nathan Zaia: and a half billion in capital that can be returned 159 00:08:46,290 --> 00:08:50,010 Nathan Zaia: to shareholders. I think on the capital side and ability 160 00:08:50,010 --> 00:08:53,250 Nathan Zaia: to fund dividends, I think they're pretty well- placed on 161 00:08:53,250 --> 00:08:53,699 Nathan Zaia: that front. 162 00:08:54,420 --> 00:08:56,849 Sean Aylmer: Let's go away from the big four. Some of the 163 00:08:56,849 --> 00:09:01,290 Sean Aylmer: smaller banks, Bendigo and Adelaide, Bank of Queensland, et cetera. 164 00:09:01,290 --> 00:09:04,770 Sean Aylmer: Then there's other lenders. Late last week, the government said 165 00:09:04,770 --> 00:09:07,740 Sean Aylmer: that it wants to have a review to help some 166 00:09:07,740 --> 00:09:10,230 Sean Aylmer: of those smaller lenders inject a bit more competition into 167 00:09:10,230 --> 00:09:13,499 Sean Aylmer: the market, et cetera. How difficult is it for the 168 00:09:13,500 --> 00:09:16,679 Sean Aylmer: listed players? Let's talk about Bank of Queensland, Bendigo, and 169 00:09:16,679 --> 00:09:21,390 Sean Aylmer: Adelaide to compete with the majors because of that cost 170 00:09:21,390 --> 00:09:22,560 Sean Aylmer: of funding issue primarily. 171 00:09:23,460 --> 00:09:27,598 Nathan Zaia: Yeah, it is difficult. It's the cost of funding issue, and 172 00:09:27,599 --> 00:09:31,170 Nathan Zaia: it's compounded by the cost of their operations, so the 173 00:09:31,170 --> 00:09:35,848 Nathan Zaia: operating expense. If you think about their spend on technology, 174 00:09:35,850 --> 00:09:40,950 Nathan Zaia: risk and compliance, their innovation, all of it, it's proportion 175 00:09:40,950 --> 00:09:43,260 Nathan Zaia: of their loan book. They're having to spend more, so 176 00:09:43,260 --> 00:09:46,920 Nathan Zaia: you've got lower margins, and then you've got more spend 177 00:09:46,920 --> 00:09:49,559 Nathan Zaia: on operating expenses, so a higher cost of income ratio. 178 00:09:50,280 --> 00:09:53,279 Nathan Zaia: The two of them together, you end up with a 179 00:09:53,279 --> 00:09:57,240 Nathan Zaia: poorer return for shareholders. Yeah, they are in a difficult 180 00:09:57,240 --> 00:10:00,780 Nathan Zaia: position and yeah, it'll be interesting to see exactly what 181 00:10:01,080 --> 00:10:04,860 Nathan Zaia: the government proposes. I mean, some of the things like 182 00:10:05,130 --> 00:10:09,120 Nathan Zaia: notifying a transaction holder you have coming off your bonus 183 00:10:09,120 --> 00:10:11,218 Nathan Zaia: period, that sort of thing. Yeah, it might help a 184 00:10:11,219 --> 00:10:14,640 Nathan Zaia: little bit, but it doesn't mean it pushes more people 185 00:10:15,059 --> 00:10:19,470 Nathan Zaia: into some of those non- major banks, or does it 186 00:10:19,470 --> 00:10:21,840 Nathan Zaia: mean the same problem for the non- major banks that 187 00:10:21,840 --> 00:10:23,460 Nathan Zaia: do have some transaction? 188 00:10:23,550 --> 00:10:23,819 Sean Aylmer: Yeah. 189 00:10:24,000 --> 00:10:27,270 Nathan Zaia: It's difficult. I'm not sure exactly what the proposal will 190 00:10:27,270 --> 00:10:31,230 Nathan Zaia: look like, but yeah, it's difficult to overcome that advantage 191 00:10:31,230 --> 00:10:31,710 Nathan Zaia: the majors do have. 192 00:10:31,710 --> 00:10:36,208 Sean Aylmer: Do you expect ANZ to get Suncorp's banking assets? 193 00:10:36,570 --> 00:10:39,480 Nathan Zaia: It looks pretty likely. I would be surprised if the 194 00:10:39,480 --> 00:10:43,170 Nathan Zaia: treasurer blocked it after all the hurdles it's overcome. 195 00:10:43,500 --> 00:10:45,870 Sean Aylmer: Yeah. Nathan, thank you for talking to Fear and Greed. 196 00:10:46,230 --> 00:10:47,340 Nathan Zaia: No problem. Thanks for having me. 197 00:10:47,850 --> 00:10:51,150 Sean Aylmer: That was Nathan Zaia, senior equity analyst at Morningstar. This 198 00:10:51,150 --> 00:10:53,460 Sean Aylmer: is the Fear and Greed business interview. Remember, this is 199 00:10:53,460 --> 00:10:56,730 Sean Aylmer: general information only, and you should seek professional advice before 200 00:10:56,730 --> 00:10:59,699 Sean Aylmer: making investment decisions. Join us every morning for the full 201 00:10:59,700 --> 00:11:02,340 Sean Aylmer: episode of Fear and Greed, daily business news for people 202 00:11:02,340 --> 00:11:05,759 Sean Aylmer: who make their own decisions. I'm Sean Aylmer. Enjoy your day.