Wrapping The Australian Bank Results

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

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

By Greg Peel

[The recent articles Australian Banking Sector Update and Westpac Fails To Excite are prologues to this epilogue.]

“Credit growth remains muted,” noted Commonwealth Bank's ((CBA)) management at its quarterly update on Monday, “reflecting sustained de-leveraging and ongoing caution on the part of both the consumer and the business customer”.

If ever there were a statement that best sums up the state of the Australian banking sector at present, that's it. And CBA's first quarter (September) was over before the RBA hiked its cash rate this month.

Having now learned banking results of one form or another from all of National Bank ((NAB)), ANZ ((ANZ)), Westpac ((WBC)) and Commonwealth along with the two leading regional banks and the hybrid that is Suncorp-Metway ((SUN)), the only conclusion is that “it's tough out there”. Ostensibly all the banks are facing (1) weak credit demand as (2) funding costs rise and (3) subdued operational earnings as (4) operating costs increase.

The press and politicians have had a field day with what appeared to be huge jumps in bank sector profits, but they're all idiots and the reality is that outside of bad debt provisions quarantined in FY10 being brought back to bottom line earnings in FY11, bank profits would have been pretty poor. Let's look at the CBA result.

In the September quarter, CBA actually surprised brokers by producing even “some” pre-provision profit growth, in the order of 2% from the previous quarter. This was despite a 4 basis point contraction in the net interest margin (NIM) – one might say a bank's raison d'etre – to an all-time low of 2.15%. CBA was able to offset the effect of margin contraction on profits by pulling back on discretionary spending, and the 4bp NIM contraction was net of a 7 basis point increase in funding cost offset by raising lending rates in areas other mortgages.

With all the visceral frenzy being whipped up in the outside world over banks this past month, bank analysts treated the CBA result as one might a stoic 50 being scored by a previously injured batsman who'd returned to play on after having retired hurt. Small earnings forecast increases followed from most analysts, but even those are putting faith in that which CBA itself putting faith – that the second half of FY11 will see the long awaited recovery in credit demand because it just ain't gonna happen in the first half.

Of course, since the close of reporting dates, and even since all of the NAB, ANZ and CBA releases, all the banks have moved to reprice their mortgage rates by up to 20 basis points above the RBA's cash rate move. While the source of all the lynch mob anger, the out-of-cycle hikes have had little impact on analysts who had expected exactly such all along, other than most had conservatively assumed only 15bps of added hikes. The repricing confirmations have made no difference to expectations of subdued bank profit growth ahead at least until, hopefully, things start to look a little rosier as we enter calendar 2011.

So if that hope takes care of point (1) above, the repricing goes some way to sorting out point (2). Deutsche Bank, for one, calculates CBA's 20 variable mortgage rate addition will add 8bps to the group NIM, for example. But of course the offset of raising NIM's is that it can only come at the expense of already weak credit demand. CBA noted de-leveraging is still the trend in both retail and business banking, especially for Small and Medium Enterprises. Higher rates are not going to spark any confidence to re-leverage.

So this will ensure that point (3) remains the state of play until such time as, for whatever reason, demand does begin to pick up. Fortunately banks are seeing growth in their lending “pipelines” (credit applied for but not yet drawn upon) which is how they can make the claim that growth is ahead. Given banks don't lend much to mining companies, there is no clear link between Australia's commodity-led GDP growth expectations and the expectations for bank profits.

The banks can point to falling unemployment as encouragement, but then this is still to make an assumption that employed workers will once again become credit card and short-term loan junkies as they were in the pre-GFC era. As for housing finance, well we can argue till we're blue in the face about whether there is or isn't a housing “bubble” in Australia and whether or not it will pop, but I'm happy to stick my neck out and say that the house price “boom” is over for now. Maybe for a while.

On the cost side, Westpac's Gail Kelly addressed point (2) in an interview on America's CNBC this morning by yet again reiterating that her bank's funding cost will not see a peak until 2012 when it begins to replace post-GFC “expensive” longer term bonds with new bonds at cheaper rates, rather than replacing the “cheap” bonds still providing funds at present with more expensive ones.

In the case of (4), all banks are currently in some process of spending money to upgrade computer systems and so forth which is just as natural part of life in an era when new hardware and software are already redundant the minute it's ready to be switched on. And such requisite spending is coming at a time when earnings growth possibilities are limited. Westpac, for one, intends to offset some of this cost by “increasing productivity” which is PR spin for cutting its workforce. Even then, these “productivity” gains will be initially costly given payout requirements.

The good news is that the Big Banks have all been able to bring back more of the bad and doubtful debt (BDD) provisions than analysts had expected at this stage, which largely reflects a lower peak and more rapid fall in BDDs than previously expected post-GFC. But the “rapid” part is now over. CBA has pointed to ongoing increases in BDDs in the business lending division and a more limited rate of decline from here in group BDDs.

Outside the Big Four, the BDD situation is not quite as comfortable. Analysts are still worried that the regional banks are overexposed to further BDD growth and under-provisioned, while Suncorp surprised analysts yesterday by actually announcing an increase in BDDs in the quarter when all other banks are enjoying declines. The bank cum insurer surprised analysts even more by announcing it had at the same time reduced BDD provisions, and Macquarie, for one, pointed to alarming anecdotal evidence of the parlous state of the Queensland residential property market in reiterating its negative view on SUN.

All of the above is not a scenario in which you'd expect a central bank to raise really, is it? But oh yes – iron ore.

So where does analyst consensus on the Big Four sit now, post all the results? Well let's have a look at our updated table:

The first thing that leaps out is the the Big Two of the Big Four look like lukewarm porridge at the moment. Analysts agree that the premiums individually deserved by the Big Two over peers are about right now, and without any pressing capital issues post the Basel III requirements there's not a lot to be concerned about, but then nothing much to be inspired by either. Indeed, I have never previously seen even one complete set of Hold ratios at any time I've ever updated this table, and now there's two.

For the Small Two of the Big Four, it's clear ANZ remains the pin-up bank. Unless you hold a contradictory view to everyone else and believe ANZ has run its margin superiority race already, which is Macquarie's view. NAB, on the other hand, has the analysts largely polarised. It all comes down to just how quickly one believes business credit demand can rebound, as that is most important to NAB.

As a rule of thumb from past experience, analysts will tend to be content with Hold ratings right up until upsides to targets start exceeding the 10% mark. That's why double digit upsides do not always attract Buy ratings from everyone. 

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