The Financial System Inquiry (FSI) recommends the banks hold ever increasing capital levels.  From 4%-4.5% pre-GFC to >12.2% in the future.  The current zeitgeist post GFC is a de-gearing, de-leveraging world, with debt as evil and debt free the new black.  Fair enough.  The Australian banks are expected to do their part in this and hold “unquestionably strong’ capital levels.
 

This means current Core Equity Tier 1 (CET1) levels of 10.0%-11.6% (comparable global basis) will need to be increased to over 12.2% in time.  Further, to de-risk the banking system and increase competition, the risk weighting on housing will be increased from c18% to 25%-30%.
 

The above two recommendations (to increase capital level to the top quartile of global banks and lift risk weighting on housing) and the general stability of the banking system are for APRA to determine the FSI recommends.  The government will seek industry feedback and  want bipartisan support for any changes.  Recommendations likely to be mid-year.
 

The FSI acknowledged there could be a cost to the economy and interest rates.  +1% to the banks CET1 if passed on to consumers add 10bps to a loan and lowers GDP by 10bps.  So if the impact is +2.4% to CET1 (+1% CET1 for risk weighting increase and +1.4% to CET1 to get to 12.2%) this will add 0.24% to loan rate and lower GDP by 0.24%.  This is likely to be spread over a number of years and competition likely to lower impact.  The FSI see any cost as worth it in strengthening the banking sector, the economy, and lowering the risk to tax payers having to bail out the banks.
 

None of the will surprise the market following the interim report six months ago and market speculation of additional capital requirements.  The market had been expecting the CET1 to increase by 2% (slightly better) and risk weighting to increase to 20% (so slightly worse).  So the report is not to different from market expectations.  There is further consultation to go, and it will be up to APRA to set the levels of new capital and the timing.
 

The report will benefit the regionals (BOQ, BEN, SUN), as the will not be required to hold more capital and their risk weighting are already c38%.  So any passing on the higher capital requirements to consumers by the major banks to maintain profitability will allow the regionals to undercut major bank pricing or boost the regional profits if they follow suit. 

The bottom line is that banks (if not passed on to consumers) will become more capital intensive, payout ratios will be capped, growth in in EPS and DPS will be lower, as will Return on Equity (ROE).  How the cost is  split between bank shareholders and consumers being the unknown here.
 

Assuming no pass on to consumers, if the government and APRA implement the recommendations by 2017, the banks could meet the increased capital requirements by heavily under writing their dividends reinvestment plans (by up to 65% over the next few years).  This would impact sector EPS/DPS in 2017 by -5%, -1% from ROE, and growth rates will be only 2%-4%.  Banks would have minimal EPS growth and would become pure yield plays.  However, we expect APRA to give the banks transition arrangements until 2019 which will half the impact.  Further, the banks will pass on a reasonable amount of the cost.

So the impact is likely to be a few percent of EPS and maybe 50bps of ROE.

James Gerrish 

Senior Adviser 
Shaw Stockbroking 

**Sourced from Shaw Research - General Information Only**
 

 

1, About 50% of all ASX listed companies are classified as resources. That accounts for about 30% by mkt capitalization. There in lies our first problem. Iron Ore is down $60 this year, Oil & other energy is down substantially. Global investors are negative resources (and China), so therefore have a negative bias towards a resources dominated mkt such as ours - particularly one that's so heavily linked to China. To give some perspective, only 11.6% of the S&P 500 is made up of materials and energy (3.2% for materials)

 

2. Financials account for about 37% of the ASX by mkt cap, of that banks make up about 27%. Concerns around the Murray Inquiry and higher capital requirements is playing a factor here. I think it's more a case of fear the unknown...once some regulatory clarity is provided, banks will probably rally...but until then, not a lot of support being offered by the sector. (hopefully this weekend we have the recommendations)

 

3. So, we've got almost 60% of our mkt that's got some earnings headwinds at the moment, and this comes at a time when the Government seems to be losing it's swagger - and is short the numbers to do anything meaningful about our growing budgetary issues.  

 

4. The talk of an Australian recession has been building. Govt revenues will be hit on lower commodity prices, mining investment has come off fairly hard and the risk remains around the pick up in non-mining investment activity - and whether it will employ those losing jobs in mining.

 

The Aussie dollar is likely to go lower (meaning international investors are unlikely to weigh in to our mkt in any meaningful way) - and we've got a distinct lack of 'new world' stocks - as they do in the US where 20% of the S&P 500 is made up of IT coys. 

 

So they're probably the main reasons why the world is running with the 'sell Australia' thematic. 

 

Should we be concerned? 

 

I know - as I've been reminded of lately, that i've been bullish equities. There are reasons for it and contrary to popular opinion, there are certainly times in the past, and will be in the future, that i'm bearish - but we're simply not there yet. Yes, Australia faces some headwinds, and yes we should look to diversify our holdings by asset class (bonds) as well as geography (Soon will be putting general ideas out on US stocks for those that want to ad US exposure to their portfolio's) - but that doesn't mean we should be outright negative on Aussie stocks.  

 

1. Concern of an Aussie slowdown is rife, but we haven't actually seen it. Growth is sluggish, and there is a decent hole left from mining - but other parts of the economy are starting to do OK. The risk is, they don't do well enough to fill the void, but again, the evidence just isn't there yet to make that call. 

 

Non-Mining capex ticking higher 

 

Aussie growth

 

2. Australia is linked to China, and a significant fall in the Iron Ore price is a concern, both on sentiment and perhaps more importantly, with regards to our balance of payments. Iron Ore will find a floor though, and demand from China will continue. Here is the recent view from the RBA...which I think is sensible. 

 

“Many of the long-term drivers of the original increase in demand for commodities from China are still in play. The Chinese economy is continuing to evolve in ways that will support demand for resources, and the sheer size of the economy suggests that these demand forces will, over the medium to long term, remain strong.” 

 

3. Inflation is low, the labour market has slack and confidence is benign - thus interest rates will stay at or around current levels for a long time to come - as I've said consistently, longer than most anticipate. 

 

Of course we'll have periods of uncertainty where stocks go down - that's the nature of the beast. The issue is whether the selling is based on structural issues or is sentiment driven - I think at the moment this is a sentiment driven sell off. 

James Gerrish 
Senior Adviser 
Shaw Stockbroking 

Medibank (MPL) has been sold to Institutions at $2.15 - whilst retail investors will get stock at $2.00. From what I hear, Institutions who bid $2.20 got about 40% of what they bid for, so there was solid demand at prices above that. Expect an open around $2.20/30 - but it could go higher. Stock will list midday on Tuesday 25th November. 

 

Our Analyst in the sector, David Spotswood, has lifted our valuation from $1.97 to $2.25, which represents a 15% premium to NHF - and a 12.5% discount to the Healthcare Sector. Assuming the stock opens around $2.30, we would have a hold on the stock. At $2.50, it looks pricey. 


§  The table below shows what MPL should trade at if priced on the other healthcare stocks PE ratio.


§  Healthcare stocks Growth versus PE, MPL at $2.15






Sourced from Shaw Research. 

James Gerrish 
Senior Adviser 
Shaw Stockbroking 

***General Information Only***

Byron Wien, an Asset Consultant for Blackstone in the US - and someone I've read/followed for the past 15 years, has recently put out another mkt update (3rd Nov)...He covers the correction we've just had, what next for equities and provides some insight following a recent trip to the Middle East...well worth a read in my view - or for those that are just interested in the mkt comments....

 

I believe we are in a prolonged period of slow growth in the United States, Europe and Japan. As a result I think a favorable environment for stock prices could continue for several more years. In my mind, valuations are not excessive and equities can appreciate in price in accordance with earnings increases. I do not expect much in the way of multiple expansion, except perhaps at the end of the cycle when everyone becomes comfortable that the good times are going to last forever and nothing is ever going to go wrong. That’s when the “animal spirits” take over.

Full article available; http://www.blackstone.com/news-views/market-commentary/blog-detail/byron's-market-commentary/2014/11/03/the-long-awaited-correction-and-a-report-from-the-middle-east


James Gerrish 
Serior Adviser 
Shaw Stockbroking 

Wollies reported Q1 sales yesterday -of +3.9% (below Coles +5.8%). A bit disappointing. No change to our forecasts (yet)...but clearly below mkt expectations + below Coles

 

- WOW continues to report qtrly supermarket sales below Coles, and in that environment “cost out” becomes critical to sustaining WOW’s dominant business model.

 

- Shaw has forecast 4.4% group sales growth for the FY 2015 (up from +0.2% in 2014) and at this point we will not be downgrading our forecasts. However unless there is improvement at the HY there is a slight downgrade potential ahead. We have forecast group EBIT margins to improve from 6.2% in 2014 to 6.3% in 2015 (as this is a Q1 sales update, WOW has not provided any guidance update for profits).

 

- Aust F&L represents around 87% of group EBIT, and so improving both sales and profit margin for this segment is critical.

 

The following chart shows the ongoing relative strength of Coles compared to Woolworths, as Coles continues to reclaim its natural market share:




James Gerrish 
Senior Adviser 
Shaw Stockbroking