Company Reports

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.

MyState is a small listed Australian bank, commanding a tiny 0.3% of the mortgage market. A key point of difference, though, is MyState’s large exposure to housing, and in particular, owner-occupied and low loan/value ratio loans. Housing loans make up most of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Because of its size, MyState struggles to generate comparable margins to the majors, as it has a much smaller customer base and higher funding and operating costs.

MyState’s first-half fiscal 2024 cash net profit after tax fell 5% on the prior half, with net interest margins dropping nine basis points to 1.46%. The small bank is feeling the pressure of intense price competition for customer deposits and loans. Focused on low loan/value ratio, home loan management is tempering loan growth, up just 1% in the half, but does aim to increase loans in line with the market in fiscal 2024. Lending into the first home buyer scheme market resuming and an appetite to lift investor loans (where MyState is underweight peers) should support growth. The bank is highly dependent on the mortgage broker channel, and in this market, price is likely taking precedence over the speed of approval. With higher funding costs and less scale, it’s understandable that MyState needs to pause its ambitions to quickly expand the loan book, at least until more rational pricing, to prevail. The bank also responded by lowering staff and marketing costs, bringing operating expenses down 1.5%. However, the bank cost/income ratio increased to a weak 64.4%.

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.

MyState is a small listed Australian bank, commanding a tiny 0.3% of the mortgage market. A key point of difference, though, is MyState’s large exposure to housing, and in particular, owner-occupied and low loan/value ratio loans. Housing loans make up most of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Because of its size, MyState struggles to generate comparable margins to the majors, as it has a much smaller customer base and higher funding and operating costs.

We reduce our fair value estimate for MyState by 4% to AUD 4.80 per share. As a small bank focused on home lending, the no-moat bank is feeling the pressure of intense competition among the four major banks and Macquarie Bank, weak credit growth, and elevated refinance activity. With net interest margin being squeezed by higher term deposit pricing and discounted mortgage rates, management has decided to temper loan growth. MyState now expects to grow loans in line with the market in fiscal 2024, compared with prior guidance of growing two times faster. We now forecast loan growth of around 4% in fiscal 2024, down from 7% previously. NIM is guided to be 1.45% to 1.49% in first half 2024, down from 1.55% in the second half of fiscal 2023. MyState is highly dependent on the mortgage broker channel for loans, and in a refinance market, price is likely taking precedence over the speed of approval. So as large banks offer lower rates and cashbacks despite a slower approval process, MyState is having to compete. Despite containing cost growth so far in fiscal 2024, lower NIM and loan balance results in EPS guidance being lowered 7.5% to 12.5%.

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.

MyState’s fiscal 2023 cash net profit after tax increased 20% to AUD 38.5 million, with 14% loan growth helping offset weaker net interest margin and rising operating costs. The result missed our expectations by 3.5%, though. The funding cost disadvantage to major banks, as MyState is more reliant on savings and term deposits, was more pronounced than we expected. When customer saving rates peaked and banks got away with paying very little for customer deposits, small banks more reliant on term deposits benefited most. The difference in the cost of funds between major and nonmajor banks narrowed, but this appears to be widening again in a higher-rate environment. MyState’s NIM fell 4 basis points to 1.63%, with the second half down to 1.55%. In contrast, Commonwealth Bank's NIM increased 17 basis points to 2.07% in fiscal 2023.

MyState’s result was solid, with the bank on track to meet our fiscal 2023 net profit forecast of AUD 42 million. Net interest margin, or NIM, was admittedly much weaker than we'd forecast, but larger average loan balances provided a welcome offset.

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.

No-moat MyState’s fiscal 2022 profit fell 12% to AUD 32 million, slightly weaker than our forecast of AUD 34 million. Loan growth of 26% was strong, outpacing system growth of 8% over the year. This was expected, though, as the bank deployed capital after raising equity in June 2021. Earnings and ROE should improve as the bank gets the annualized benefit of the larger loan book. Despite solid loan growth, net interest income was down 1.6% from fiscal 2021, the result of a sharp fall in net interest margins, or NIM, of 29 basis points to 1.67% over the year. With higher marketing and distribution costs required to support the growing loan and deposit books, operating costs increased 13%. We had already expected growth to come at the cost of lower margins and higher operating expenses, and while the result was a little weaker than expected, it is not material enough to have an impact on our AUD 5.50 fair value estimate.

Environmental, social and governance, or ESG, factors can have a material bearing on the cash flow and valuation of firms. In the past, issues such as James Hardie’s asbestos liability or AMP’s management of its conflicts of interest have had a material impact on the valuation of those firms. Identifying and assessing ESG risks is critical to any thorough assessment of a company’s cash flow and earnings potential. At Morningstar, we incorporate ESG into our long-term-oriented methodology by focusing on issues with the highest risk, defined by likelihood and materiality to a company’s intrinsic value.

No-moat-rated MyState’s first-half fiscal 2021 profit bounced back 13% to AUD 17 million. The result and outlook exceeded our expectations. Loan impairments look likely to be lower than first feared, margins are better than expected on an influx of customer deposits, and operating costs are being well managed. We have raised our fiscal 2021 net interest income and operating income forecasts by 5% and 9%. Our fair value estimate increases 4% to AUD 5.20 per share on better short-term earnings and the time value of money. MyState is currently fairly valued.

MyState Ltd is one of Australia’s smallest listed banks, commanding a tiny 0.2% of the mortgage market. A key point of difference though is MyState’s large exposure to housing, and in particular, owner occupied and low loan/value ratio loans. Housing loans make up around 95% of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Due to its size, MyState struggles to generate comparable margins to the majors, mainly due to its much smaller customer base and higher funding and operating costs.

MyState Ltd is one of Australia’s smallest listed banks, commanding a tiny 0.2% of the mortgage market. A key point of difference though is MyState’s large exposure to housing, and in particular, owner occupied and low loan/value ratio loans. Housing loans make up around 95% of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Due to its size, MyState struggles to generate comparable margins to the majors, mainly due to its much smaller customer base and higher funding and operating costs.

We have increased our fiscal 2021 dividend forecasts across our banking coverage following APRA’s announcement that from 2021, the regulator will no longer require banks to limit distributions to 50% of earnings. We had assumed the restriction would be in place until fiscal 2022, but the improvement in the economic outlook, sharp decline in temporarily deferred loans, and the banks’ capital positions, provide us comfort the move is not too early. The increase to dividends is not material to our fair value estimates. We continue to see Westpac as modestly undervalued, ANZ and National Australia Bank fairly valued, and Commonwealth Bank overvalued. On our updated numbers, the banks trade on fully franked fiscal 2021 dividend yields of 3.5% to 4.5%.

MyState Ltd is one of Australia’s smallest listed banks, commanding a tiny 0.2% of the mortgage market. A key point of difference though is MyState’s large exposure to housing, and in particular, owner occupied and low loan/value ratio loans. Housing loans make up around 95% of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Due to its size, MyState struggles to generate comparable margins to the majors, mainly due to its much smaller customer base and higher funding and operating costs.

Tasmania-based MyState Ltd is one of Australia’s smallest listed banks, commanding a tiny 0.2% of the mortgage market. A key point of difference though is MyState’s large exposure to housing, and in particular, owner occupied loans. Housing loans make up around 95% of MyState’s total loan book, in comparison to roughly 65% (on average) for the major banks. This contributes to the bank’s sound credit quality, with the lowest arrears and bad debts in the industry. Due to its size, MyState struggles to generate comparable margins to the majors, mainly due to its much smaller customer base and higher funding and operating costs.

We have lowered our earnings and dividend forecasts for the banks, but with share prices down by as much as 40%, all are materially undervalued on our revised fair value estimates, or FVEs. Our fiscal 2021 forecasts are down between 6.5% to 11%, with National Australia Bank affected most by heightened risk of small business' defaults. On average we assume another 5 basis point reduction in NIM from fiscal 2021, with bad debts rising to around 22 basis points of loans, up from our previous expectation of 13 basis points. Dividends are also expected to fall across our coverage list. While near-term headwinds continue to mount, our FVEs are predicated on our view that the long-term cash rates will normalise and the majors will continue to benefit from cost advantages and switching costs, which underpin their competitive advantages.

Despite a recovery in Australian house prices, which supports credit growth and low bad debts, the Reserve Bank of Australia, or RBA, cut the cash rate 25 basis points in recognition of economic risks from the global coronavirus outbreak. The major banks will pass on the cut in full. This is great for borrowers but puts net interest margins, or NIMs, under pressure. We lower our valuations by 2.5% to 5%, with lower near-term earnings driven by margin compression.