Australia | Nov 01 2019
ANZ Bank's FY19 result confirmed the challenges faced by a banking sector that needs to find new areas of growth while grappling with narrowing interest margins.
-Cost reduction targets is likely to require more investment
-Difficulties persist with Australian loan growth
-Franking on dividends reduced to 70%
By Eva Brocklehurst
As the first of the three major banks to report its financial results this month ANZ Banking Group ((ANZ)) encompassed the broad scope of market concerns and will face another difficult year. Further investment is considered likely in order to sustainably reduce the bank's cost base.
Morgan Stanley forecasts underlying revenue to fall -3.5% in FY20, with negative operating leverage driving a -10% decline in pre-provision profit. The broker also forecasts a -10 basis points decline in margins.
Regulatory costs are likely to remain elevated, in Credit Suisse's view, while the pick-up in housing finance applications may not flow through to overall credit growth because of a higher paying down of mortgage debt by borrowers.
FY19 cash earnings were $6.47bn, below most expectations, driven by lower net interest margins. Morgans actually found the results better than feared as costs, asset quality and capital were all pleasing elements.
On a mildly positive note too, softer revenue was offset by lower-than-expected bad debts and Credit Suisse points out earnings quality was enhanced by a higher effective tax rate, albeit affected by declining provision coverage.
The bank has confirmed its medium-term (FY22 exit) cost base target of $8bn which UBS considers positive, provided cost reductions are undertaken in the correct manner and do not disrupt the franchise.
Morgan Stanley believes the cost target will require more investment and also a material reduction in the bank's footprint as well as a reshaping of the workforce. This could then create a risk of further losses in market share if peers do not take the same path.
Macquarie agrees that it will be difficult for ANZ Bank to materially outperform peers on costs without damaging the franchise. This view is reinforced by the first half FY20 expense guidance of around 4%, ahead of possibly more remediation and restructuring costs.
The bank is lowering its hurdle rate to increase growth opportunities, particularly in institutional banking as this will offer potential for faster growth. Citi considers this the right strategy, as institutional banking was already growing at 7% and offers high single-digit returns, not too dissimilar from the front-book (new customer) mortgages that peers were chasing.
Morgans assesses investors are adopting negative views on net interest margins for the other major banks as a result of ANZ Bank's disappointing performance. This may be unjustified, as the broker calculates the retail net interest margin in Australia actually increased in the second half, with positive implications for more retail-oriented banks.
Morgans believes the main problems for ANZ Bank lie with the institutional and New Zealand divisions, and more specifically the compression being generated in margins on deposits in these divisions. The broker suspects official rate reductions, both domestically and offshore, pose a greater problem for ANZ Bank because of the nature of its markets business.
While the FY19 results may be partially a reflection of specific issues related to ANZ Bank, Macquarie still asserts the underlying pressures on the sector remain broad-based. The broker suspects ANZ Bank will need to raise capital levels by around $4bn over the medium term, given pending rules changes from the Reserve Bank of New Zealand, and despite what appears to be a robust pro forma CET1 ratio of 11.5%.
The bank has warned that loan growth is unlikely to materially increase, despite a housing recovery, stating "volume growth is going to be close to zero".
ANZ Bank has lost market share in mortgages recently, Bell Potter notes, with the mortgage portfolio declining by -$7bn in FY19. The bank has moved to rectify the issue through increasing transparency on policy and risk settings and improving processing and turnaround times.
Bell Potter, not one of the seven monitored daily on the FNArena database, was underwhelmed by the results and has reinstated a Hold rating with a target of $28, given the 12-month return is expected to be less than 11% amid ongoing regulatory and operating headwinds.
The second half dividend was maintained at $0.80 but the bank has cut the franked portion to 70%. UBS believes ANZ Bank is likely to hold its dividend at current levels, if asset quality remains benign and rates do not fall much further.
Franking should not be an issue for other major banks, Morgans suggests, as these derive a greater proportion of their statutory earnings from Australia and have healthier surplus franking credit balances. Citi is of a similar view and expects ANZ Bank will retain this level of franking for a while. The benign credit environment should allow for a stable dividend and provide some valuation support.
Morgan Stanley disagrees and expects a dividend reduction is more likely in 2020, lowering its full year estimate to $1.40. The broker cites the fact ANZ Bank has previously described a 60-65% pay-out ratio as providing a conservative, sustainable and fully franked dividend base for the future. This would imply a -20-25% cut to the dividend, although the broker suspects the bank will aim to remain above this level, even with lower franking.
Ord Minnett points out while the valuation of 12.5x FY21 estimated earnings looks cheap compared with other major banks, the discount is justified given the number of challenges and significant execution risk facing ANZ Bank.
FNArena's database has six Hold ratings and one Sell (Credit Suisse). The consensus target is $26.31, suggesting -0.3% downside to the last share price. Targets range from $24.80 (Morgan Stanley) to $28.00 (Citi). The dividend yield on FY20 and FY21 forecasts is 5.8%.
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