Concerns for the big four centred on a slowing housing market,increasingcompetition and the fallout from RoyalCommission related issues. This in direct contrast to Macquarie Group (MQG) who had a strong level of expectation baked into its price and therefore needed to impress on the upside to sustain its price levels.

By now most readers will know the bank reporting season was above expectations, except for the Commonwealth Bank of Australia (CBA) whose quarterly update showed the strain of increased regulation. But for those that reported, the clear message from the reporting season was that the banks are taking appropriate measures to adapt to a more regulatory intensive and lower growth environment.

Financial Health

From a bottom-up perspective, all the banks remain in Strong Financial Health and continue to exhibit accounts more stable than most developed nations. All appear on track to meet the 2020 deadline to hold APRA’s Common Equity Tier 1 (CET1) ratio target of 10.5%, with ANZ exhibiting the strongest capital levels at 11%.CBA and National Australia Bank(NAB)aremore dependent on the divestment on non-core assets to reach the target level, with CET1 ratios of 10.1% and 10.2% respectively.The banks are also benefitting from pristine credit quality as impairment charges remain at historically low levels. Therefore, our banks are exposed to acceptable levels of financial risk.

Return on Equity (ROE)

The days of strong double-digit growth for the banks have been well and truly behind them for quite some time. However, investors would have been heartened that on a cash adjustedbasis, the ROE from their investments remained stable. A stronger focus on cost control and lower impairment charges generally improved the bottom line. MQG displayed the most significant expansion in ROE as it rose to16.8%due tohigher levels of operating income and a lower expense ratio and tax rate. The exception was NAB where ROE declined due to an increase in expenses related to an acceleration in its simplification strategy.

Net Interest Margin (NIM)

NIMsmeasure the interest income generated versus the amount of interest paid out to their lenders. The out performer was Westpac Banking Corporation(WBC) who increased itsNIM 7bps on 2H17 to 217bps, reflecting higher treasury income and the full effects of the previous repricing of investor and interest-only loans. Though the results were solid across all banks, each referred to the rising cost of wholesale funding as a risk to margins in the near-term.

Dividends

All the banks were able to maintain a stable dividend this period though MQG lifted itsfull-year dividend by 11.7% to $5.25. Pleasingly, WBC joined MQG and ANZ in being placed within their respective stated dividend payout ranges. BothANZ and MQG  have already startedshare buyback programs with plenty of headroom for further capital managementinitiatives.All dividends were fully franked, except for MQG which was franked at 45%. Of some concern was NAB, who maintained an elevated payout at 81% of adjusted cash net profit with a relatively weaker capital position. Though confident they can support this through the cycle, we will watch closely for points of strain.

End diagnosis?

Following the reports, we are happy to retain each of the banks as Star Income Stocks[i]. Each delivered standout results relative to expectations,except for NAB who offset their sluggish performance with the news it will sell its wealth management arm.

From an investment perspective, the bank'searnings growth challenges have been evident for some time. However, for income-seeking investors who value their consistent and stable fully franked dividend payments, each remains a staple holding.

Investors seeking more dynamic double-digit growth stories will need to continue to look elsewhere, however, of the current cohort, MQG offers the most optimistic long-term growth outlook.

From here on in, without an immediate catalyst for dynamic business growth, banks will continue to be range bound as they have been for the past few years (except MQG.) Therefore, investors will need to continue to bank on the dividends as their major source of earnings.

• CBA provided a quarterly update. It is due to report their full set of accounts in August 2018
• Prices as at 08 May 2018
• MQG is a 2nd tier bank and subject to a 10% CET1 ratio by 2020

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ELIO D’AMATO

Lincoln Indicators is a fund manager and creator of Stock Doctor. Elio D‘Amato is the Executive Director at Lincoln Indicators. www.lincolnindicators.com.au

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