More Bank Doubt; NAB ‘s UK Plan

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The last two weeks has seen a gradual shift in attitude among bank analysts with regard to bank earnings expectations for FY10 and FY11. The shift comes as we approach the bank earnings season (dates appear at the end of this article) and as the ASX 200 looks to push through pre-GFC levels.

While three of the Big Four banks have now reached new post-GFC highs (and post early Greek weakness) the exception being National Bank ((NAB)), focus in the last month has been squarely on the resource sector – on coal and iron ore price increases and sector consolidation. These stocks have had a good run and the chatter from institutional investors is that now might be the time to take profits and shovel the winnings back into the banking sector.

It is the nature of the ASX 200's two dominant sectors by market capitalisation – diversified resources and banks – that the two undergo opposite ebbs and flows of popularity within the general trend. Large investors are often switching out of one and into the other. However, such institutional chat is to some degree at odds with the growing scepticism of bank analysts.

Two weeks ago RBS suggested the market was overestimating the expected rebound in business lending into FY11. Last week Macquarie argued all expected non-mortgage lending growth is already well priced in, and that likely regulatory changes threatened to reduce margins. FNArena noted bank share prices are close to average broker targets (ex-NAB) which either means target upgrades or recommendation downgrades, with the latter more likely ahead of the results period. Citi downgraded outperformer ANZ Bank ((ANZ)) last week for that very reason.

This morning it is Deutsche Bank's turn, this time with the focus on competition.

It is well appreciated that the initial global credit crisis and ultimately the GFC destroyed the loan securitisation market and substantially increased bank borrowing costs. The loss of a securitisation market meant the demise of non-bank lenders and a strain on smaller banks while smaller banks also suffered from a big blow-out in credit spreads on borrowings. As a result, we effectively lost St George and BankWest along with RAMS Home Loans and others.

Through both this impact and a general rush by Australians back to the comparative safety of the big banks, the Big Four picked up substantial market share and were able, in particular, to exploit the government's first home buyer hand-outs.

But Australia's economy is back growing strongly again, rates are rising, and the memory of the GFC is fading. Inevitably as things return to “normal”, that normal state includes a re-establishment of banking competition to at least some extent. The government still hopes to reinstate the securitisation market. But within the market share gains of the Big Four has also been a variance of business mix strategies. As each bank has targeted a particular area of banking they have offered competitive rates and discounts in the hope of picking up market share. For example, having let mortgages slip in the great stimulus rush, NAB is now offering competitive rates which is likely to result in the other three having to lower their spreads as well.

“We believe structural imbalances will drive increased competition,” says Deutsche, “which is likely to reduce spreads by 6-20 basis points”. This will result in interest margin pressure.

The analysts suggest actual margins will increase in the near term but over the medium term competition will impact. They see a 6-11bps reduction in group spreads from mortgage competition, 5-10bps in small and medium enterprise lending and 5-8bps for institutional lending.

And there will also be effects from the other side of the ledger. Tighter tier one capital requirements will force more robust competition for deposits.

Deutsche sees the larger Commonwealth ((CBA)) and Westpac ((WBC)), who picked up the lion's share of new mortgages for one, as more vulnerable to fiercer competition from the smaller NAB and ANZ. All up, Deutsche believes the 3-5bps of margin reduction currently built into consensus forecasts is too low, and thus consensus earnings forecasts are at risk of medium term downgrades of 5-10%.

There are a number of reasons NAB continues to underperform its peers, with uncertainty over the AXA-AP ((AXA)) bid one of them. Another is NAB's UK assets and what the bank plans to do with them. NAB is torn between an exit strategy from what has proven a disastrous foray or a “double up to catch up” which involves exploiting current low valuations in the UK market.

RBS notes a media report in the UK press on the weekend which suggests NAB's UK CEO Lynne Peacock has a “double or quit” strategy for the UK market. On the one hand, NAB has put in a bid to buy RBS' UK assets. On the other, it's apparently looking to float off its UK asset Clydesdale Bank for some 2bn pounds.

On the balance of those two conflicting intentions, RBS suggests the leaning is toward an exit strategy. For one, a value of 2bn pounds for Clydesdale would be 3-4% earnings dilutive by the broker's calculation with a value of 3bn pounds being about earnings neutral. So it would be something of a fire sale.

However, the broker feels the divestment of Clydesdale would lift the “PE drag” NAB is suffering as the market applies a discount to NAB based on UK uncertainty. Thus earnings dilution would be offset by closing that discount gap. On the flipside, NAB's bid for the RBS assets seems too low to even make the short list of bidders and NAB has stated no interest in bidding for the assets of Lloyds or Northern Rock currently owned by the UK Treasury and soon to be auctioned.

All up, RBS suggests NAB is good value currently at a 12% discount to its peers and thus RBS (Australia) rates it a Buy.

In the meantime, Credit Suisse sees ANZ as the bank with the best chance of a positive earnings surprise from its interim result. ANZ is comparing to some significant loan impairments from a year ago so is likely to show the greatest reduction in its bad and doubtful debt levels, Credit Suisse suggests.

CS is restricted on NAB at present, but rates CBA top pick followed by NAB and Westpac.

Bank of Queensland ((BOQ)) will report on April 15, ANZ on April 29, Macquarie Group ((MQG)) reports its full-year on April 30, Westpac reports its interim on May 5 and NAB on May 6.

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