Betting against big banks a risky business

The Australian banks are at the top of their game. In the opinion of some that makes them a sell, but betting against them has been a loser's strategy and the 11 per cent higher $6.5-billion September year profit that ANZ chief executive Mike Smith handed down on Tuesday suggests that state of affairs will continue.

Theories that the banks will be short-sold by hedge funds as proxies for an Australian housing market crash or an economic slowdown have been around for years, but powerful franchises, world-leading profitability and a combined 25 per cent weight in the Australian sharemarket make them dangerous ground for shorting, which involves an up-front commitment to sell shares backed by a plan to acquire the shares that will be delivered later, at a lower price. In this market, every sector except the telcos is shorted more aggressively than the banks.

It's not unusual to hear the argument that bank shares are set for a fall, nevertheless. They are at an earnings peak where the view is wonderful but the next step in any direction is down, so the argument goes. Banks in the US and Europe meanwhile are half as profitable, but back in favour: their returns are climbing and could jump 50 per cent if the northern hemisphere economic recovery goes to plan.

Betting against the Australian banks has not paid off so far, however. In the past five years their share price gains and dividends have produced a total shareholder return of 134 per cent, twice as good as the return delivered by the S&P/ASX 200 index as a whole. They have returned 44 per cent in the past year, outpacing the ASX 200 index's return of 26 per cent. Betting against them in future might also be unwise: they are the investment equivalent of an ATM machine.

Questions are being asked about the wisdom of ANZ's push into Asia, and it's true that so far it hasn't supercharged the group's earnings profile.

The $6.5-billion cash profit that Smith unveiled on Tuesday was nevertheless 11 per cent up on the previous year after a 5 per cent rise in net interest income was leavened by a 3 per cent reduction in costs, and ANZ boosted Australian divisional earnings and international and institutional divisional earnings by 11 per cent and 15 per cent respectively.

Across the group, costs as a percentage of income fell from 46.1 per cent to 44.1 per cent. Smith knows that further cuts are crucial because loan growth is subdued, and he has set a target of 43 per cent or less for the 2015-2016 year.

He says ANZ will continue buying market share - in the Australian market in the September year it posted the strongest growth in home loans, deposits and credit cards - and says the group also aims to return at least 16 per cent on equity employed in 2015-2016. ANZ's ROE rose by 0.2 percentage points to 15.3 per cent in the year to September, a return that was strong but not predatory, despite complaints from the Greens that as usual focused on the dollar size of the profit, not the money that was deployed to earn it.

The main force behind ANZ's 1.2 per cent share price rise on a day when the market fell by half a per cent was a dividend bump and a bullish dividend guidance.

ANZ's board pushed the final dividend up from 79¢ a share to 91¢ to carry the full-year payout from $1.45 to $1.64, a raw yield of 4.9 per cent on ANZ's share price that rises to 7 per cent when franking credits are loaded in. The payout absorbed $4.5 billion or 69 per cent of the $6.5-billion cash profit, and ANZ said it could pay between 65 per cent to 70 per cent of earnings in the medium term, with a near-term bias towards the upper end of the range.

The payout outlook is key to understanding the banks. Dividend yield is becoming less important to investors as the sharemarket rises and the need for capital protection is overtaken by the desire for capital gain, and loan growth is about a third of its pre-crisis levels, but ANZ and its big local banking competitors are still in a virtuous circle: earnings and dividend increases are driving share price gains that further boost shareholder returns, and there is no obvious reason why it can't continue.

mmaiden@fairfaxmedia.com.au