June 12, 2013 3268 VIEWS

Tuesday, June 12, 2013 / By Adam Haigh* / Bloomberg



Australian banks posted the best risk-adjusted returns among global peers in the past 10 years, attracting investors with rising earnings and the highest dividend yields of the world’s biggest lenders.


Commonwealth Bank of Australia, the country’s No. 1 lender by market value, had the highest returns when adjusted for price swings of the largest companies in the MSCI World Bank Index with a market capitalization of more than $5 billion, the BLOOMBERG RISKLESS RETURN RANKING shows. Westpac (WBC) Banking Corp. and Australia and New Zealand Banking Group Ltd. ranked fourth and seventh.


The Commonwealth Bank of Australia logo is displayed at a bank branch in Sydney. Commonwealth Bank’s $100.5 billion market capitalization now tops the $75 billion value of Goldman Sachs Group Inc., Wall Street’s top merger adviser last year.


Against a backdrop of almost 22 years without a domestic recession, Commonwealth Bank’s market value has exceeded that of Goldman Sachs Group Inc. and Mitsubishi UFJ Financial Group Inc., Japan’s largest lender. While high valuations and a worsening economy are clouding the growth outlook for the country’s banks, dividend yields of as much as 8.9 percent have helped keep volatility well below that of peers.


“Australian banks have been the biggest beneficiary of flows to the highest-yielding stocks,” BinayChandgothia, Hong Kong-based fund manager at Principal Global Investors, where he helps oversee $292 billion, said by phone June 6. “You had Australian growth that was doing well and the banks have made great progress in terms of stable profitability.”


No Recessions

Bank profits grew as the Australian economy expanded uninterrupted since 1991, a record unmatched by any other advanced nation. The Reserve Bank of Australia kept its benchmark interest rate among the highest in the developed world to stem inflation.


Commonwealth returned a risk-adjusted 18 percent over the 10-year period through May 31, helped by a volatility of 24, compared with the average of 40 for the group. Westpac returned a risk-adjusted 11 percent in the same period, with a volatility of 26, and ANZ returned 8.7 percent with a volatility of 27.


Oversea-Chinese Banking Corp. (OCBC), Southeast Asia’s second-biggest lender, ranked No. 2 for risk-adjusted return during the past 10 years, the data show. BOC Hong Kong (Holdings) Ltd., a unit of Bank of China Ltd., the nation’s fourth-largest lender, ranked third.


The MSCI World Bank Index comprises 91 lenders listed in developed markets with a combined market capitalization of $2.6 trillion. The index doesn’t include companies such as New York-based Goldman Sachs and Charlotte, North Carolina-based Bank of America Corp. Shares of both U.S. firms trailed their Australian counterparts over the past decade on a risk-adjusted basis, according to data compiled by Bloomberg.


Record Prices

The risk-adjusted return, which isn’t annualized, is determined by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.

Six of the 10 worst performers were banks in Europe, where a recession has curbed growth and increased the proportion of soured loans. The worst performer when adjusted for volatility was Spanish lender Banco Popular Espanol SA (POP), followed by Germany’s Commerzbank AG, according to data compiled by Bloomberg. Italy’s Unicredit Spa (UCG) was the third-worst performer, the data show.


Australian banks, like the rest of the global financial industry, suffered during the 2007 to 2009 financial crisis. After reaching a record in November 2007, Commonwealth shares tumbled 61 percent in 14 months as lenders set aside more money as asset values slumped during the global financial crisis that began in the U.S. A doubling of bad debts through 2008 further crimped earnings growth at Commonwealth to the slowest pace in four years.


Unlike many peers in the developed world, ANZ, Westpac and Commonwealth all reached records within the first five months of this year. Record profits, higher dividend payout ratios and low bad debts fueled a 10 percent gain in Australian bank shares in 2013 through the end of May. Overseas investors bought Australian bank shares, lured by the income the lenders pay to investors, as bond yields sank amid unprecedented stimulus by central banks from the U.S. to Europe and Japan.


‘Modest’ Risk

After reaching a six-year low in January 2009, Commonwealth shares surged 205 percent to a record on May 20 this year. Commonwealth’s $99 billion market capitalization now tops the $80 billion value of Goldman Sachs, Wall Street’s top merger adviser last year. Japan’s Mitsubishi UFJ (8306) is worth $89 billion.


That pace probably won’t last. Earnings growth at Australian lenders will be slower than average as an aging population, low mortgage growth and increased regulation weaken the outlook, Melbourne-based Goldman Sachs analyst Matthew Ross said in a report dated May 29. He forecasts medium-term growth in earnings per share of 5 percent, below the yearly average growth of between 10 percent and 20 percent.


“Banks’ earnings risk is modest, dividends are safe and yields remain attractive,” Richard Wiles, a Sydney-based analyst at Morgan Stanley, said in a report dated May 31. “A further decline in the Australian dollar would drive a de-rating because it would likely reflect a weaker domestic economic outlook, and it could also lead to increased selling of banks.”


Slower Growth

The Organization for Economic Cooperation and Development last month cut its 2013 growth forecast for Australia to 2.6 percent, from 3 percent projected in November, citing currency strength and fragile business confidence. Australia’s economy expanded less than economists forecast last quarter as manufacturers and builders detracted from growth. The nation’s investment boom may have peaked after companies scrapped or put off A$150 billion ($145 billion) of mining and energy projects in the past year, the government said last month.


An era of lack luster growth and low returns that has plagued the world economy since 2008 has now reached Australia, according to Newport Beach, California-based Pacific Investment Management Co., which has $2 trillion of assets worldwide and manages the biggest bond fund.


‘Bad Debts’

“You don’t need a crisis or a housing bust, but any sort of pickup in bad debts is going to pressure profits at banks,” Sean Fenton, a Sydney-based fund manager who helps oversee about $1 billion at Tribeca Investment Partners, said by phone on June 3.


Australia’s S&P/ASX 200 Banks Index fell 13 percent in May, the most in a year, as the Aussie currency plunged 7.7 percent against the dollar, reducing the appeal of Sydney-listed shares for overseas investors, according to Wiles of Morgan Stanley.


Still, the gauge is up 252 percent in the 10 years through the end of May including reinvested dividends, beating a 123 percent total return by the MSCI World Index and a 109 percent gain by the Standard & Poor’s 500 Index.


Dividend yields of 8.7 percent at Westpac and 9.2 percent at National Australian Bank are more than double the 3.7 percent average estimated payout on the MSCI World Bank Index, according to data compiled by Bloomberg. ANZ pays 8.1 percent and Commonwealth (CBA) 7.9 percent, the data show.


Payout Ratios

Westpac, Australia’s second-largest lender by market value pays 85 percent of its earnings to shareholders through dividends, according to data compiled by Bloomberg. Commonwealth Bank has a dividend payout ratio of 75 percent, the data show.


That payout ratio has helped keep volatility for the four banks around 20 this year, compared with 32 for group, despite the selloff in May.


Australia’s four pillar banks, a name derived from a law that prevents the four biggest lenders from buying each other, all trade with forward price-earnings multiples higher than the 11.4 times average for the MSCI World Bank Index. ANZ trades at 11.7 times estimated profit and Westpac has a multiple of 12.5. NAB trades at 11.3 and CBA at 14.1.


“The growth story for the long term is now on a knife edge,” said Fenton. “Banks look overpriced, but that’s supported by abnormally low interest rates and extraordinary measures of quantitative easing in various parts of the world. As long as that environment persists, they will do well. They’re delivering strong dividend yields and that’s going to stay important in this low-interest-rate environment.”


To contact the reporter on this story: Adam Haigh in Sydney at ahaigh1@bloomberg.net


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