(TUESDAY 28TH JUNE - 07.58 - JAMES GERRISH)...The US market closed higher overnight with the DOW JONES up +109pts & the S&P 500 adding +0.9%. Buying came on the back of reports that new financial regulations surrounding bank capital requirements were not as onerous as some were anticipating + optimism that the US banks were in a better shape to meet new regulations than the market has given credit for. Tech stocks and Financial shares led the charge on Wall Street while Commodities came under a bit of pressure. The USD was lower as was the Aussie. the FUTURES market is pricing in a rise of +49pts when trading kicks off this morning.
Our Banks...to BUY or not to BUY
Mixed opinion is rife when it comes to the banks at the moment with the valuation argument being countered by calls of anaemic growth and a pending property crash that will bring the sector to its knees. So, should we be buyers of the banks or not?
I think it comes down to one question and the answer will dictate your actions. Are bank dividends sustainable???
During the financial crisis we saw a lot of companies ratchet back dividends as credit markets seized. The turnaround is well under way and we've seen banks increase dividends as profitability has rebounded. As it stands, the average dividend in the sector is 7% and when you ad in franking credits, this jumps to an impressive 9.9% - pretty attractive in a Self Managed Super Fund. This compares to the long term average of 5.6% + franking and as Goldman Sachs points out in a recent article, this implies a 1.94% premium to 10 year bond yields and a 2.08% premium to cash rates.
So, will the payout ratios prove unsustainable and we'll see dividend cuts or will the dividends support higher stock prices in the sector.
I'm in the second camp largely based on the belief that dividends are sustainable. This is supported by countering some of the concerns below which I believe has been putting pressure on the sector .
1. Threat of New Capital Requirements - Although we're yet to get the final determination on these there was progress made over the weekend with key central bankers agreeing on how they are going to approach banks deemed too big to fail.
Banks that are regarded as globally systemically important will be subject to capital requirements in addition to the new Basel III minimum core capital requirement of 7%. The regime will see a tier one common equity capital surcharge of between 1% and 2.5% depending on their importance to the global Financial System. (This is less than 3% that was initially thrown around).
The likes of JP Morgan, Citigroup, HSBC, Bank of America etc will be subject to the max surcharge while lesser banks will be scaled between 1% and 2.5%. If the Australian Banks were included in the second tier of lesser banks, all Australian banks are likely to achieve a tier 1 capital ratio in excess of the requirements. This should alleviate concern that dividends would be cut or capital would need to be raised to meet the requirements + it also highlights the already conservative approach taken by Australian banks.
2. The impact of lower loan growth is overblown - There is no doubting that the operating environment has become more difficult and loan growth will be harder to come by, however even in a 0% growth scenario, the current dividend payout ratios do not appear stretched and its likely they would be maintained even in a 0 growth scenario
3. Dividend Payout Ratios - leading on from the last point, the average payout ratios currently stand at 50% against a historical average of 49% - so from historical standards they are by no means stretched.
So given the reasons above, I think dividends will be maintained and ultimately these will be supportive of prices as the banks trade back in line with historical averages.
We've been a recent BUYER of CBA given its the bank to pay the next dividend while we also hold ANZ & Westpac.
BHP
BHP is on track to complete its $10 billion share buy back program within days - 6 months sooner than we were expecting. This has sparked rumours that it will unveil another initiative when it releases its Full Year results in August. Any rumour of capital management is likely to be a positive for BHP.
AUSTRALIAN STOCK PRICES OVERNIGHT
In New York, News Corp rose by US$0.17 to US$17.44, equivalent to A$16.70, A$0.35 above its last close on the ASX.
ResMed fell by US$0.10 to US$29.95, equivalent to A$2.87, A$0.02 above its last close on the ASX.
In London, Rio Tinto rose 20.5 pence to £42.68, A$0.31 higher in Australian currency terms.
BHP-Billiton rose 12.5 pence to £23.13, A$0.19 higher in Australian currency terms.
Henderson Group Plc was unchanged at £1.45.
DIVIDENDS TODAY
None
US ECONOMIC ACTION
Jun-27 - Personal Income (For: May , Actual: 0.3%, F/Cast: 0.4%, Prior: 0.3%)
Jun-27 - Personal Spending (For: May , Actual: 0.0%, F/Cast: 0.1%, Prior: 0.3%)
Jun-27 - PCE Prices - Core (For: May , Actual: 0.3%, F/Cast: 0.2%, Prior: 0.2%)
Jun-28 - Case-Shiller 20-city Index (For: Apr , F/Cast: -3.9%, Prior: -3.6%)
Jun-28 - Consumer Confidence (For: Jun , F/Cast: 60.8, Prior: 60.8)
