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Is the bank play in trouble?

05 May 2015  |  Investing

BankWestpac came in with a poor profit result on Monday and announced a dividend of 92 cents rather than the 93 cents the market expected.It is still a strong yield, but is it a sign of future earnings weakness in the banks? Goldman Sachs and Morgan Stanley certainly think so. They have both downgraded the bank and caste doubt on the future profitability of the sector.

The AFR is reporting that Credit Suisse has maintained its underperform rating, and is beginning to suspect that the entire banking sector may be re-rated:


"Goldman Sachs downgraded Westpac from buy to neutral and Morgan Stanley from equal-weight to underweight on the back of Monday's result in which Westpac announced a cash profit of $3.78 billion in the six months to March 31. 


The result was $100 million below analysts' expectations and flat compared to a year ago. The bank also disappointed investors by lifting its dividend by less than expected - a 93 cent fully franked dividend rather than 94 cents.  

Westpac and the other major banks faced a number of profitability headwinds, said Goldman Sachs. A number of these were related to the mooted tightening of bank lending by the Australian Prudential Regulation Authority.

In particular, a move to higher mortgage risk weights and higher capital requirements would impact on the sector. 

"We expect APRA to increase mortgage risk weights for the major banks to 25 per cent post the Financial System Inquiry," said Goldman Sachs. By contrast, Westpac's current mortgage risk weight was just 16 per cent.

In summary Westpac faced a 2.5 per cent return on equity headwind, said Goldman Sachs. The firm reduced their 12-month target for the stock to $37.47 from $38.34."Morgan Stanley's 12-month price target for Westpac has been lowered from $33 to $30.70. The broker is saying that the growing pessimism about the housing market is eating into profitability:

"We forecast...a lift in the average mortgage risk weightings to 26 per cent," said Morgan Stanley. 

"However, we see the risk of even more onerous requirements for investment property loans, which account for over 46 per cent of Westpac's Australian mortgage book."


Westpac's result was "ringing the bell for the sector", which it descibes as "expensive". The big question facing investors is will the banks in future be as good an investment as they have been in the past. Given the narrowness focus of most SMSF's equity exposure -- there has been a heavy bias towards large cap stocks that pay high ranked dividends -- it is an important question.




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