Is the tail of the 'great bank dividend story' finally wagging?
With the 'big-four' banks continuing to trade at significant discounts to their intrinsic value, the negative sentiment currently being dished out to bank stocks has changed little since we covered the recent downfall earlier in the year.
As explained back in February, what's been driving the sell-off experienced by the sector at large is mounting fears over bad debt charges which Australian banks will be forced to take.
Since then, some of these fears have finally come home to roost with the ANZ Bank (ASX: ANZ) recently raising its forecast for loan losses by $100 million – on top of the $800 million charge the bank anticipated when it released its first-quarter trading update on 17 February 2016 – with management attributing the blame on unprofitable clients within the resource sector, some of which may never have the capacity to repay their debts.
In response to these revelations, the bank's share price recently fell by around 10 percent. While ANZ claims that mounting loan losses remain a small part of its total loan book, they were significant enough for some analysts to factor in a 10% cut to its dividend compared with last year.
Admittedly, bad debts experienced by Australian banks have always been modest compared with their offshore counterparts.
But what's concerning is that falling bad debt charges that have helped drive bank earnings higher in recent years – especially CBA's – could be in a reverse trend over the next few years.
It's no secret, bad debt charges have been creeping up in the wake of the mining boom crash, and the fuller impact of debt default still remains largely unknown with more liquidations likely to follow that of (unlisted) Queensland Nickle.
As the two bank stocks most at risk, it's understood that ANZ and Commonwealth Bank of Australia (ASX: CBA) both have around $20 billion each in exposure to resources-related credit.
Having been in a cyclical low for some time, impairment charges are now in what appears to be an uptrend and this is evident in the changes in bad debts experienced by three of the big-four, with CBA, Westpac (ASX: WBC) and ANZ experiencing changes in bad debts of 7.63%, 15.85% and 19.57% respectively.
It's true, Australian banks are among the most profitable in the world, and rising bad debt provisions can be relatively easily absorbed. However, like it or not, the market regards heightened bank debt risk a big deal, and rightfully so, with increasing bad debt provisions expected to impact profitability.
However, while it does appear that the local bank sector has been left over-sold since the routing dished out to over the last 12 months, further bad news is expected for the global sector at large, which means local banks are likely to come under greater weakness going forward.
Heading into earnings season, analysts have cut their expectations for almost three-quarters of the companies in the S&P 500's financial sector, and low interest rates, regulation and exposure to the troubled energy sector continue to cast a shadow over bank shares this year – making the financial sector the worst performer in the S&P 500 in 2016.
In light of continued margin pressure on Australian banks, softer lending growth, plus offshore funding issues, downgrades by analysts on all banks are in store, with flat or falling dividends likely to come under greater pressure.
Any unwinding of the market's exposure to banks, on the back of any hints we're in a lower dividend environment, will only create further downward pressure on the bank share prices.
Neither ANZ nor NAB look aggressively priced, but it's ANZ that appears to be the most oversold.
Given that it's still priced for a good outlook – at two times book – with the share price trading on a 0.5 – 1 multiple greater than ANZ and National Bank of Australia (ASX: NAB), CBA has been left looking the most exposed.
As the largest dividend payer on the ASX, CBA paid $3.4 billion [in dividends] to shareholders when it announced its result for the six months to 31 December 2015.
Interim results for the other three major banks in the first week of May will come under intense scrutiny by the market, especially any changes to dividend policy.
It's clearly too early for bell-ringers to call time on the long-running 'bank dividend story'. But we'll get a much better idea of the fuller implications over the next 18 months, depending in part, on what happens to domestic interest rates in the meantime.
With further downward pressure expected for banks, there's no compulsion to buy at current levels. Short sellers should keep their eyes open for short-term opportunities.