Company Reports

On a weighted average basis, major bank share prices increased 28% in the 12 months to June 30, 2024, outperforming the 8% increase in the Morningstar Australia Index. It is hard to pinpoint a single specific driver for the turnaround in bank sentiment. On the earnings front, signs of repricing loans and deposits to protect margins and low loan losses, are positives. But global funds increasing ownership and inflows into passive funds has likely also supported prices.

The Federal Treasurer has approved wide-moat ANZ Group’s acquisition of Suncorp Bank from no-moat Suncorp, the final hurdle on a deal announced back in July 2022. No direct job losses for three years is a commitment which was already made by ANZ, with the Treasurer adding additional conditions that Suncorp maintains regional branch numbers nationally and endeavors to maintain banking services with Australia Post. We don’t think the cost of either is material to the combined group and have little bearing on the financial success of this deal for ANZ.

ANZ Group is the owner of ANZ Bank, the smallest of Australia's four major banks by market value and the largest bank in New Zealand and the Pacific, offering a full range of banking and financial services to the consumer, small business, and corporate sectors. Like the other major banks, ANZ Bank has a well-recognized and trusted bank brand, large advertising and marketing budget, and customer fulfilment capacity (branches, systems, funding capacity) to capitalize on this brand equity. We see the firm’s strategy to simplify and focus on its highly profitable core banking operations as logical. The acquisition of Suncorp Bank came as a surprise but provides an avenue to leverage benefits of recent investment in its retail banking platform. Integration risk can not be ignored, but overall we believe the acquisition makes strategic sense.

ANZ Group is the owner of ANZ Bank, the smallest of Australia's four major banks by market value and the largest bank in New Zealand and the Pacific, offering a full range of banking and financial services to the consumer, small business, and corporate sectors. Like the other major banks, ANZ Bank has a well-recognized and trusted bank brand, large advertising and marketing budget, and customer fulfilment capacity (branches, systems, funding capacity) to capitalize on this brand equity. We see the firm’s strategy to simplify and focus on its highly profitable core banking operations as logical. The proposed acquisition of Suncorp Bank came as a surprise but provides an avenue to leverage benefits of recent investment in its retail banking platform. Integration risk can not be ignored, but overall we believe the acquisition makes strategic sense.

ANZ Group’s cash profit fell 7% on a very strong previous corresponding period, and down a more modest 1% on the second half of fiscal 2023 as the margin tailwind of cash rate increases continued to be competed away. The negative earnings trajectory has slowed, though, and we expect it will begin to improve in fiscal 2025. With less refinancing activity, a pick-up in new lending, and the term funding facility repaid, we think margins should modestly improve over the medium term on more favorable loan and deposit pricing. However, lower margins might be acceptable if the industry extracts cost savings or reports lower credit losses than historical levels to offset lower revenue growth.

After reasonably uneventful earnings updates, it is hard to pinpoint a single specific driver for the turnaround in bank sentiment. Still, we think part of it is that a likely lower cash rate eases housing fears and provides banks an opportunity to reprice loans and deposits to protect margins. Major bank share prices increased 23% since November 2023, outperforming the 16% increase in the Morningstar Australia Index over the same period. The major banks' weighted average price/fair value estimate is 1.14, up from 1.05 in the last quarter. Nonmajor banks trade at a price/fair value of 0.85.

Originally announced in July 2022, ANZ Group’s acquisition of Suncorp Bank is almost over the line. The Australian Competition Tribunal granted approval and overturned the Australian Competition and Consumer Commission’s earlier rejection. Federal Treasurer approval and changes to Queensland state law are required, but the competition regulator was the biggest obstacle, in our view.

ANZ Group is the owner of ANZ Bank, the smallest of Australia's four major banks by market value and the largest bank in New Zealand and the Pacific, offering a full range of banking and financial services to the consumer, small business, and corporate sectors. Like the other major banks, ANZ Bank has a well-recognized and trusted bank brand, large advertising and marketing budget, and customer fulfilment capacity (branches, systems, funding capacity) to capitalize on this brand equity. We see the firm’s strategy to simplify and focus on its highly profitable core banking operations as logical. The proposed acquisition of Suncorp Bank came as a surprise but provides an avenue to leverage benefits of recent investment in its retail banking platform. Integration risk can not be ignored, but overall we believe the acquisition makes strategic sense.

We reiterate our AUD 31 fair value estimate for wide-moat ANZ Group. The first-quarter 2024 update revealed revenue in line with the quarterly average of first half 2023, with loan growth offsetting unquantified net interest margin, or NIM, pressure. This is positive in our view, given elevated price competition for mortgages and deposits.

Australian banks face low credit growth, softer net interest margins, and an increase in loan losses in the short term. Industry returns on equity will be suppressed in fiscal 2024. However, we expect loan and deposit pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate maintainable returns above our 9% cost of equity.

ANZ Group is the owner of ANZ Bank, the smallest of Australia's four major banks by market value and the largest bank in New Zealand and the Pacific, offering a full range of banking and financial services to the consumer, small business, and corporate sectors. Like the other major banks, ANZ Bank has a well-recognized and trusted bank brand, large advertising and marketing budget, and customer fulfilment capacity (branches, systems, funding capacity) to capitalize on this brand equity. We see the firm’s strategy to simplify and focus on its highly profitable core banking operations as logical. The proposed acquisition of Suncorp Bank came as a surprise but provides an avenue to leverage benefits of recent investment in its retail banking platform. Integration risk can not be ignored, but overall we believe the acquisition makes strategic sense.

ANZ Group’s 14% increase in fiscal 2023 cash profit to a record AUD 7.4 billion is largely as we expected. The result was driven by net interest margins up 7 basis points to 1.7%, loan growth of 5%, and bad debt expenses remaining low at 4 basis points of average loans. Earnings weakened over the year, with second-half profit down 6% on the first half, and this negative earnings trajectory likely why ANZ Group continues to trade at a material discount to our unchanged AUD 31 fair value estimate.

The short-term outlook for Australian banks is challenging with margins under pressure, loan losses expected to rise, and inflationary cost pressures unable to be offset by cost-cutting initiatives. Industry returns on equity are suppressed, hence we expect loan and deposit-pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate returns above our 9% cost of equity.

With interest margins softening and bad debts likely to rise, at least investors could take comfort in the banks sitting on surplus capital. With an average common equity Tier 1 ratio of 12.1%, all Australian major banks comfortably exceed the regulatory requirement of 10.25%. The Australian Prudential Regulation Authority does expect banks to maintain a buffer though, hence major banks have set their own targets of 11%-11.5%. This surplus capital position could be under threat if APRA sees fit to shake up the hybrid market.

We make no change to our AUD 31 fair value estimate for wide-moat ANZ Group following a brief third-quarter update. Highlights include above-market lending volume growth, a strong capital position, and a moderate rise in loan book stress.

Australian wide-moat major banks are comfortably meeting regulatory capital requirements, sitting on an aggregate excess capital of nearly AUD 15 billion as of Sept. 30, 2022. COVID-19 induced conservatism saw major banks cut dividends, tighten lending standards, divest assets, and in the case of Westpac and National Australia Bank, raise equity. Because of this, the majors are entering a downturn both well-capitalised and having enjoyed historically low loan losses given the accommodative monetary policy and fiscal stimulus in response to the pandemic. As at Sept. 30, 2022 on average, the four major banks had impaired and past due loans as a proportion of total loans of 46 basis points compared with 64 basis points as at Sept. 30, 2019.

The Australian major banks expectedly reported improvements in net interest margins, or NIMs, in the fourth quarter of fiscal 2022.

The increases in the Reserve Bank of Australia cash rate to arrest inflation will have an impact on key earnings drivers for the banks. With the cash rate currently at 2.35%, and likely north of 3% by year-end, the increases from just 0.1% in April 2022 have been swift. It is expected to slow credit growth, with less borrowing capacity and confidence (a complete turnaround from the fear-of-missing-out environment of recent years). However, we think bank sector revenue growth will be buoyed by higher net interest margins, with the spread between lending rates and the cost of customer deposits widening.

Given strict regulatory requirements, banks usually have sound balance sheets, making decisions around investment strategy (including loan growth and quality) and distributions more important in determining shareholder returns. On balance sheet strength and distribution strategies it’s a level playing field across the major banks in our opinion, but we think Commonwealth Bank has edged its peers on strategy and execution. We assign a Standard capital allocation rating across the banks, but we think the pendulum is swinging close to an exemplary rating for Commonwealth Bank, while Westpac and National Australia Bank are closer to Poor. We make no other changes to our earnings forecasts or fair value estimates.

ANZ’s cash profit of AUD 3 billion puts the bank on-track to meet our full-year expectations. The AUD 678 million release of loan loss provisions (a benefit to profit) was better than expected, but was largely offset by volatile global markets income softening.