Why buybacks for CBA, NAB, ANZ and Westpac are coming to an end
Morgan Stanley has slashed share buyback expectations for the Big Four Banks after February reporting season.
Source: iStock
Mentioned
KEY POINTS
- In the latest February reporting season, the Big Four Banks’ CET1 ratios missed analyst expectations, potentially limiting future capital management options like share buybacks, according to Morgan Stanley
- Buybacks are set to peak in FY25 with no new ones expected after current $2.6 billion completes, reflecting tighter CET1 targets
- In terms of dividend outlook, CBA is forecast to grow its ordinary dividend by 22% from FY24-27, while the other three majors lag at 1-5% growth
Since August 2021, Australia’s Big Four Banks have returned significant cash to shareholders, announcing $9.5 billion in off-market buybacks and $19 billion in on-market repurchases, according to Morgan Stanley. To add some perspective, that's roughly the market cap of Coles, the 22nd largest company on the ASX.
Buybacks provide a flexible way to hand excess cash back to investors without locking into ongoing dividends. By reducing the number of shares outstanding, they lift key metrics like earnings per share, making the stock look more appealing. Often, a buyback hints that management sees the shares as undervalued.
However, this era of capital management may be coming to an end.
The major banks’ December 2024 CET1 (Common Equity Tier 1) ratios came in weaker than expected. The CET1 ratio is a key measure of how much high-quality capital a bank has to absorb losses during tough times.
Morgan Stanley analysts noted, “we believe that less confidence in future capital management options removes an investment positive for the major banks and makes underperformance more likely."
Capital ratios fall short
In the latest reporting season, CET1 ratios fell short of forecasts by an average of 25 basis points, a gap Morgan Stanley called “surprising and disappointing.” Adding to the challenge, APRA’s September 2024 proposal to adjust capital rules, which could lift target CET1 ratios by 25 basis points to 11.25%-11.75%.
"While the new capital requirements would only come into effect in January 2027, we believe the banks would adopt their new target ranges immediately," the analysts said.
Buyback implications
The Big Four have $2.6 billion in existing buybacks still underway, which Morgan Stanley expects to complete. But once the current buybacks finish, they expect no new ones.
After February reporting season, they cut future buyback estimates by $4 billion, then by another $3.5 billion to account for the likely CET1 target increases
Over the next three years, dividend reinvestment plan (DRP) neutralisation — where banks issue new shares to offset dividend payouts, keeping the share count stable — should continue, but buybacks are forecast to peak FY25.
Source: Morgan Stanley
Dividend outlook
Morgan Stanley predicts ordinary dividends will rise slightly from FY24 to FY27, with Westpac likely adding one more special dividend. CBA is expected to shine, with a projected 22% dividend growth over that period, while the other three majors trail at 1-5%.
Source: Morgan Stanley
Interestingly, their forecasts assume CBA will have the strongest dividend growth between FY24 and FY27, at 22%. The other Big three are forecast to have dividend growth of just 1-5%.
What does this mean for banks?
Morgan Stanley warns that 2025 could prove challenging: "We think elevated trading multiples and expectations of supportive operating conditions have set a high bar."
CBA’s price-to-earnings ratio, for example, climbed from 20.5x at the start of 2024 to a record 26x today.
They warned that "less confidence in future capital management options removes an investment positive and makes underperformance of the group more likely."
