The last few weeks have been a bonanza for shareholders in Australia’s Big Four banks, amid record full year results and handsome increases in dividend payments.
But lurking in background have been concerns over whether Australian banks are perceived as over-valued and a warning from the bank’s corporate regulator about the payment of special dividends.
In August the Commonwealth Bank of Australia led the bonanza with a 10% increase in its cash net profit to A$7.8 billion - the largest for an Australian lender - and a final dividend of A$2, up 9%.
ANZ followed in October with an 11% increase to its cash net profit up to A$6.5 billion and boosted its final dividend by 13% to A$1.64. NAB also increased its full-year cash earnings by 8% to A$5.94 billion, and increased its final dividend by 7 cents from the previous year.
The last of the Big Four to report financial results, Westpac has announced an 8% rise in cash earnings to A$7.1 billion, with its final dividend up 5% to $1.74. Significantly, Westpac has announced it will pay a special dividend of 10 cents.
Are our banks overvalued?
But how reliable is the picture of financial health being promulgated by the banking sector?
For the past several weeks, reports have been circulating that Australian banks are being stalked by foreign hedge funds. Dubious of the heady valuations that these banks have built up recently, a narrative has developed involving astute fund managers building up short positions in the hopes of profiting from a collapse - or at least a correction - in the sector.
Other voices were soon raised to rebut these claims, leaving the question still open to further debate. The use of “hedge funds” as the bogeyman here, however, is notable. Seeking out over-valued or under-valued securities in the market is, of course, precisely the function of many of these funds. To the extent that hedge fund managers provide a larger service to the entire market (and all market participants), it stems from both the liquidity they provide by actively trading in and out of securities and the resulting contribution they make to price discovery.
Putting aside the role of hedge funds as a convenient “pantomime villain” that can be rolled out when rhetorical demands require, the stability of the Australian banking sector in the medium-term is an important issue, both domestically and internationally. Both the end of the “resources boom” and the difficult lessons learned by banks around the world during the financial crisis of 2008 makes this issue particularly timely.
APRA’s marching orders
Fortunately, the regulator chimed in last week to get its views across. APRA’s marching orders are relatively straight-forward - large Australian banks should be limiting their dividend payouts to investors. New rules will require them to maintain higher capital thresholds, and excessive distributions of capital could put the banks in an awkward position if a higher-than-expected prudential charge is levied.
Investors, unsurprisingly, may be a little miffed by this approach. Australian bank shares are performing well and shareholder expectations are high. If this is not the time to reward them with higher dividends then when would be? By throwing around a somewhat vague preference for Australian banks maintaining “adequate capital buffers,” APRA seeks to rein in any over-exuberance that might take hold in the sector.
Champions of the market will argue that just as certain bank shareholders were punished in the early years of the global financial crisis by the bad decisions made by boards and senior executives, it is equally important that shareholders reap the benefits now when their banks perform well. This, however, merely replaces one line of enquiry for another, returning us again the “scary campfire stories” involving hedge funds that were circulating several weeks ago.
Are the current valuations of Australian banks correct? What long-term conclusions can and should be drawn from their recent performance?
The argument being made that these banks are being over-valued, and therefore a tasty target for fund managers wishing to short their shares and bet against their sustained good fortune, raises doubts over whether the central premise behind the payment of these special dividends is, in fact, correct.
In its own way, APRA is raising the same awkward question now that hedge funds allegedly raised earlier this year.
At their heart, financial markets are as much markets in ideas and beliefs as they are markets in securities. As a result, Australian banks will need to defend their claims of strong performance and bright prospects to not only analysts and investors, but also the dour-faced regulators tasked with checking (and double-checking) the math of the banks they oversee.