Australia Banks & Diversified Financials
More different than ever before
September 2010
Johan Vanderlugt
Tel: +61 3 9916 1335
E-mail: johan.vanderlugt@au.daiwacm.com
Share prices: close of 20 September 2010
2
Investment summary
The short- to medium-term outlook is for lower revenue growth and lower net-interest
margins (NIMs) in Australian retail and business banking, in our view.
Revenue growth is under pressure in the core retail and business banking operations (net-
interest income and fee and commission income).
Lower loan-growth forecasts (slowdown in mortgage lending, business lending still weak).
Downward pressure on NIMs due to a lack of re-pricing on home loans, and increased costs of
funding (wholesale and deposit funding).
We look for banks that can pull different levers in terms of their earnings growth and
deposit funding
Among the major Australia banks, we prefer Australia and New Zealand Banking Group (ANZ)
as we see its exposure to Asia is resulting in tangible benefits, particularly around funding.
In the diversified-financials space, we are positive on Macquarie Group (MQG) as it is well-
positioned for an earnings recovery in FY12, in our view
Our key recommendations among the large-cap Australia banks are: ANZ (Buy),
Macquarie (Outperform), Westpac Banking Group (Westpac) (Outperform), National
Australia Bank (NAB) (Hold) and Commonwealth Bank of Australia (CBA) (Underperform).
3
Valuation summary
Source: Bloomberg, Daiwa forecasts
Note: * Bloomberg consensus; closing share prices as at 20 September 2010
Australia bank valuation table
ANZ CBA NAB WBC MQG
Daiwa rating 1 4 3 2 2
Market cap, US$bn 58.1 77.1 52.3 66.3 11.9
Share price (A$) 23.96 52.58 25.86 23.43 36.49
Six-month target price (A$) 30.00 52.30 26.10 25.60 40.10
Absolute upside potential (%) 25.2 (0.5) 0.9 9.3 9.9
Target price – consensus (A$)* 25.65 53.38 27.85 24.50 41.80
Absolute upside potential (%) 7.1 1.5 7.7 4.6 14.5
PBR FY11E (x) 1.62 2.05 1.51 1.99 1.07
PBR FY12E (x) 1.52 1.88 1.40 1.91 1.01
PBR FY11E at target price (x) 2.03 2.17 1.53 2.08 1.18
PBR, past-five-year average (x) 2.23 2.36 2.12 2.74 2.16
PBR FY11E discount past-five-year avg (%) 31.7 20.3 33.9 30.5 53.3
Gross-dividend yield, FY11E (%) 5.9 6.3 6.5 5.8 5.3
Gross-dividend yield, FY12E (%) 6.8 6.8 7.3 6.2 6.3
4
Funding quality improving, while the LDR remains high
Source: Reserve Bank of Australia
The (major) Australia banks have improved the quality of their funding since the onset of the global financial crisis.
Three key developments: 1) a greater reliance on customer deposits, 2 ) increased tenure of wholesale debt, and 3) cut-backs in
securitisation.
The Australia banking market remains deposit-poor, in our view, as can be concluded from the relatively high LDRs.
Funding composition major Australia banks (%)
Source: Companies, Daiwa
Loan-to-deposit ratio (LDR) (%)
43 48
24 18
21 25
7 8
5
1
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Jun-07 Jan-10
Customer deposits Short-term wholesale debt
Long-term wholesale debt Equity
Securitisation
139.0
148.4
142.6
135.0
130.9 131.4
120
125
130
135
140
145
150
FY05 FY06 FY07 FY08 FY09 1H10
Large-cap Australian banks
5
6
Funding gap most apparent for WBC and CBA
Source: Companies, Daiwa
Westpac and CBA have shown a relatively strong appetite for loan growth, particularly as of early 2009. This relates to their greater
take-up of mortgage loans since then.
The impact of strong volume growth is a greater need for wholesale funding, which has a negative impact on NIMs.
Both ANZ and NAB have been able to improve their funding positions by showing less of an appetite for loan growth in general. This
may change, we believe, if momentum for business lending starts to improve on a more widespread basis.
Deposits versus gross loans, group level, A$bn
Source: Australian Prudential Regulation Authority, Daiwa
Deposits versus gross loans, Australia, A$bn
0
20
40
60
80
100
120
140
160
1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10
ANZ CBA NAB WBC
0
10
20
30
40
50
60
70
80
90
100
M
a
r
-
0
4
A
u
g
-
0
4
J
a
n
-
0
5
J
u
n
-
0
5
N
o
v
-
0
5
A
p
r
-
0
6
S
e
p
-
0
6
F
e
b
-
0
7
J
u
l
-
0
7
D
e
c
-
0
7
M
a
y
-
0
8
O
c
t
-
0
8
M
a
r
-
0
9
A
u
g
-
0
9
J
a
n
-
1
0
J
u
n
-
1
0
ANZ CBA NAB WBC
7
Australia banking system is deposit-poor, in our view
Source: Reserve Bank of Australia
Up until 1994, the Australian banks had LDRs of below 100%. The introduction of the mandatory superannuation regime in 1992 by
the Australia Government reduced the fiscal attractiveness of savings, while at the same time GDP growth increased, particularly in
comparison to the weak GDP growth rates of the early 1990s.
Since FY07, deposit growth (YoY) has outpaced loan growth. This illustrates three developments, in our view: 1) a greater appetite
for deposits as source of funding among banks , 2) lower demand for loans in general, particularly in the business sector, and 3) an
increasing number of investors preferring deposits over shares in terms of their asset allocation.
LDR, Australia banking market (%)
Source: Companies, Daiwa forecasts
Loan and deposit growth, major banks (YoY %)
40
60
80
100
120
140
160
J
u
n
-
8
4
J
u
n
-
8
5
J
u
n
-
8
6
J
u
n
-
8
7
J
u
n
-
8
8
J
u
n
-
8
9
J
u
n
-
9
0
J
u
n
-
9
1
J
u
n
-
9
2
J
u
n
-
9
3
J
u
n
-
9
4
J
u
n
-
9
5
J
u
n
-
9
6
J
u
n
-
9
7
J
u
n
-
9
8
J
u
n
-
9
9
J
u
n
-
0
0
J
u
n
-
0
1
J
u
n
-
0
2
J
u
n
-
0
3
J
u
n
-
0
4
J
u
n
-
0
5
J
u
n
-
0
6
J
u
n
-
0
7
J
u
n
-
0
8
J
u
n
-
0
9
J
u
n
-
1
0
0
5
10
15
20
25
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10E11E12E13E14E15E
Loan growth Deposit growth
8
Long-term perspective on loan growth
Source: Reserve Bank of Australia, Daiwa
Loan growth was relatively strong up until 2009, expanding faster than GDP growth.
On an absolute basis, net loans of the major Australia banks have surpassed total GDP since 2007.
Over the 1994-2009 period, net loan growth outpaced GDP growth by a factor of 4.7x, which we believe is unsustainable.
Our 2010-12 implied net loan growth/GDP growth multiplier of 1.6x-2.4x is well below the long-term average and more
realistic going forward, in our view, given: a) the mature status of the Australian economy, and b) our outlook of lower
economic growth compared with the favourable past two decades.
Loan and deposit growth (YoY), Australia, %
Source: Companies, IMF, Reserve Bank of Australia, Daiwa
forecasts
Comparing loan growth with GDP growth
0
5
10
15
20
25
30
35
40
J
u
n
-
8
5
S
e
p
-
8
6
D
e
c
-
8
7
M
a
r
-
8
9
J
u
n
-
9
0
S
e
p
-
9
1
D
e
c
-
9
2
M
a
r
-
9
4
J
u
n
-
9
5
S
e
p
-
9
6
D
e
c
-
9
7
M
a
r
-
9
9
J
u
n
-
0
0
S
e
p
-
0
1
D
e
c
-
0
2
M
a
r
-
0
4
J
u
n
-
0
5
S
e
p
-
0
6
D
e
c
-
0
7
M
a
r
-
0
9
J
u
n
-
1
0
Loan growth Deposit growth
0
20
40
60
80
100
120
140
160
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10E11E12E
0
2
4
6
8
10
12
14
Net loans/GDP (%) (LHS)
Net loans = GDP (%) (LHS)
Loan growth/GDP growth multiplier (x) (RHS)
Historical average loan growth/GDP growth multiplier (x) (RHS)
9
Different composition of asset-side balance sheet
Source: CBA (FY10 results presentation, 11 August 2010)
Although the Australia banks may have high LDRs in an international context, we argue that the asset side of their balance sheets is
of greater quality than that of the average UK or US bank for the following reasons:
greater portion of on-balance-sheet home loans as a percentage of total assets (varying from 32% for NAB to 52% for CBA),
lower relative amount of trading securities and other fair-value assets, and therefore less balance-sheet volatility, and
a larger portion of deposits as a percentage of total liabilities and equity.
Balance-sheet comparison: UK banks, US banks and CBA
10
Two different sets of banks (1)
Source: Australian Prudential Regulation Authority, Daiwa
CBA and Westpac have the greatest reliance on retail deposits, which is illustrative of their domestic focus and sizeable retail-
banking franchises. ANZ and NAB tend to rely more on wholesale deposits, which fits with their larger market positions in business
banking in Australia.
Westpac overtook CBA in terms of exposure to home lending in August 2007.
Retail deposits/total deposits, Australia (%)
Source: Australian Prudential Regulation Authority, Daiwa
Housing lending/total lending, Australia (%)
20
25
30
35
40
45
50
55
60
M
a
r
-
0
4
J
u
l
-
0
4
N
o
v
-
0
4
M
a
r
-
0
5
J
u
l
-
0
5
N
o
v
-
0
5
M
a
r
-
0
6
J
u
l
-
0
6
N
o
v
-
0
6
M
a
r
-
0
7
J
u
l
-
0
7
N
o
v
-
0
7
M
a
r
-
0
8
J
u
l
-
0
8
N
o
v
-
0
8
M
a
r
-
0
9
J
u
l
-
0
9
N
o
v
-
0
9
M
a
r
-
1
0
J
u
l
-
1
0
ANZ CBA NAB WBC
50
55
60
65
70
75
80
M
a
r
-
0
4
J
u
l
-
0
4
N
o
v
-
0
4
M
a
r
-
0
5
J
u
l
-
0
5
N
o
v
-
0
5
M
a
r
-
0
6
J
u
l
-
0
6
N
o
v
-
0
6
M
a
r
-
0
7
J
u
l
-
0
7
N
o
v
-
0
7
M
a
r
-
0
8
J
u
l
-
0
8
N
o
v
-
0
8
M
a
r
-
0
9
J
u
l
-
0
9
N
o
v
-
0
9
M
a
r
-
1
0
J
u
l
-
1
0
ANZ CBA NAB WBC
11
Two different sets of banks (2)
Source: Companies, Daiwa
Note: 1H FY10 data for ANZ, NAB and WBC, 2H FY10 data for
CBA. RoW = rest of the world.
CBA and Westpac have the greatest reliance on Australia and New Zealand in terms of their deposit books and loan books.
ANZ has the greatest exposure to Asia (accounting for the bulk of the 15% of total deposits and 5% of total loans), while NAB’s
dominant geographical focus outside of Australia and New Zealand remains the UK.
As such, ANZ and NAB do have some diversification benefits. We believe ANZ, in particular, has the flexibility of raising further
deposits through its network in Asia at a lower cost than in Australia.
Geographical composition of deposit book (%)
Source: Companies, Daiwa
Note: 1H FY10 data for ANZ, NAB and WBC, 2H FY10 data for
CBA. RoW = rest of the world.
Geographical composition of loan book (%)
94 91
76
67
6 9
8 18
16 15
0.0
0.2
0.4
0.6
0.8
1.0
CBA WBC NAB ANZ
Australia New Zealand RoW
91 92
75 73
9 8
11 21
14 5
0%
20%
40%
60%
80%
100%
CBA WBC NAB ANZ
Australia New Zealand RoW
12
Funding costs still high and likely to remain so
Source: Reserve Bank of Australia, Daiwa
* Note: we compare the 90-day bank bill swap rate (BBSW) with the
overnight index swap rate (OIS)
Based on the 90-day bank bill swap rate to the overnight index swap rate, funding costs are still well-ahead of pre-global financial
crisis levels (29 basis-point differential in July 2010 versus average of 10 basis points from July 2007-July 2010).
Taking CBA as an example, it follows that the bulk of the increase in its funding costs versus pre-global financial crisis levels is a
consequence of higher deposit funding costs, rather than wholesale funding costs.
Bank bill swap rate to OIS (%)*
Source: Company (FY10 results presentation, 11 August 2010)
Funding costs CBA
0
10
20
30
40
50
60
70
80
J
u
l
-
0
1
J
a
n
-
0
2
J
u
l
-
0
2
J
a
n
-
0
3
J
u
l
-
0
3
J
a
n
-
0
4
J
u
l
-
0
4
J
a
n
-
0
5
J
u
l
-
0
5
J
a
n
-
0
6
J
u
l
-
0
6
J
a
n
-
0
7
J
u
l
-
0
7
J
a
n
-
0
8
J
u
l
-
0
8
J
a
n
-
0
9
J
u
l
-
0
9
J
a
n
-
1
0
J
u
l
-
1
0
13
Re-pricing capacity on the asset side has been absorbed
Source: Reserve Bank of Australia
The Australia banks have been active over the past two-and-a-half years repricing their loan books in line with the higher cost of risk
following the 2007 global financial crisis.
In terms of the differential to the official cash rate, the re-pricing peak occurred in April 2010. For small business loans (variable,
residential secured), the differential shot up to 5.0 percentage points in April 2010 (1.8x the average level prior to the global financial
crisis). In housing loans (variable, standard), the differential increased to 2.9 percentage points in April 2010 (1.6x the average peak
level prior to the financial crisis).
Small business customers have clearly borne the brunt of the re-pricing. Until the global financial crisis, the difference between the
small business overdraft and the cash rate versus the housing loan and the cash rate used to be about 95 basis points on average.
The gap is now 205 basis points, having peaked at 230 basis points in December 2008.
Business and housing loan rate (%)
Source: Reserve Bank of Australia, Daiwa
Differential with cash rate (%)
0
2
4
6
8
10
12
J
a
n
-
0
0
O
c
t
-
0
0
J
u
l
-
0
1
A
p
r
-
0
2
J
a
n
-
0
3
O
c
t
-
0
3
J
u
l
-
0
4
A
p
r
-
0
5
J
a
n
-
0
6
O
c
t
-
0
6
J
u
l
-
0
7
A
p
r
-
0
8
J
a
n
-
0
9
O
c
t
-
0
9
J
u
l
-
1
0
Small business overdraft, variable, residential secured
Housing loan, variable, standard
Official cash rate
0
1
2
3
4
5
6
J
a
n
-
0
0
A
u
g
-
0
0
M
a
r
-
0
1
O
c
t
-
0
1
M
a
y
-
0
2
D
e
c
-
0
2
J
u
l
-
0
3
F
e
b
-
0
4
S
e
p
-
0
4
A
p
r
-
0
5
N
o
v
-
0
5
J
u
n
-
0
6
J
a
n
-
0
7
A
u
g
-
0
7
M
a
r
-
0
8
O
c
t
-
0
8
M
a
y
-
0
9
D
e
c
-
0
9
J
u
l
-
1
0
Small business overdraft, variable, residential secured
Housing loan, variable, standard
14
Margin pressure comes again from the liability side
Source: Reserve Bank of Australia
Note: 90D BBSW = 90-day bank bill swap rate (interbank lending)
In terms of the liability side of the balance sheet, interest rates on deposits typically tend to fall below the 90–day BBSW in a stable
market environment.
Some irrational competition in term deposits and online savings accounts has resulted in margin pressure on the funding/liability
side, particularly since October 2008.
We believe that now that the banks have re-priced the bulk of their loan books, in business lending and fixed-rate housing lending,
NIMs are under further pressure from higher funding costs.
Deposit rates (%)
Source: Reserve Bank of Australia, Daiwa
Differential with 90-day BBSW (%)
0
1
2
3
4
5
6
7
8
9
J
a
n
-
0
4
M
a
y
-
0
4
S
e
p
-
0
4
J
a
n
-
0
5
M
a
y
-
0
5
S
e
p
-
0
5
J
a
n
-
0
6
M
a
y
-
0
6
S
e
p
-
0
6
J
a
n
-
0
7
M
a
y
-
0
7
S
e
p
-
0
7
J
a
n
-
0
8
M
a
y
-
0
8
S
e
p
-
0
8
J
a
n
-
0
9
M
a
y
-
0
9
S
e
p
-
0
9
J
a
n
-
1
0
M
a
y
-
1
0
Cash management accounts On-line savings accounts
Term deposit 1 year 90D BBSW
(3)
(2)
(1)
0
1
2
3
4
J
a
n
-
0
4
M
a
y
-
0
4
S
e
p
-
0
4
J
a
n
-
0
5
M
a
y
-
0
5
S
e
p
-
0
5
J
a
n
-
0
6
M
a
y
-
0
6
S
e
p
-
0
6
J
a
n
-
0
7
M
a
y
-
0
7
S
e
p
-
0
7
J
a
n
-
0
8
M
a
y
-
0
8
S
e
p
-
0
8
J
a
n
-
0
9
M
a
y
-
0
9
S
e
p
-
0
9
J
a
n
-
1
0
M
a
y
-
1
0
Cash management accounts On-line savings accounts
Term deposit 1 year
15
Comparing asset and liability yields
Source: Company, Daiwa estimates
ANZ
Source: Company, Daiwa estimates
CBA
Source: Company, Daiwa estimates
NAB
Source: Company, Daiwa estimates
Westpac
(3)
(2)
(1)
0
1
2
3
1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10
Interest-earning assets to average cash rate (%)
Interest-bearing debt to 90-day BBSW (%)
(2)
(1)
0
1
2
3
1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10
Interest-earning assets to average cash rate (%)
Interest-bearing debt to 90-day BBSW (%)
(2)
(1)
0
1
2
3
2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10
Interest-earning assets to average cash rate (%)
Interest-bearing debt to 90-day BBSW (%)
(2)
(1)
(1)
0
1
1
2
2
3
3
1H07 2H07 1H08 2H08 1H09 2H09 1H10
Interest-earning assets to average cash rate (%)
Interest-bearing debt to 90-day BBSW (%)
16
Impact on NIMs
Source: Reserve Bank of Australia
Note: gap in 2006 relates to transition from A-GAAP to A-IFRS
accounting standards.
NIMs for the Australian banks declined gradually from the mid-1990s until 2009.
During FY09, the major Australia banks were able to improve their margins through re-pricing their asset books. Furthermore, strong
income in the institutional markets area, partly reported under net-interest income, had a positive impact on margins.
The theme for both FY10 and FY11, in our view, is likely to be a lack of re-pricing ability like the banks were able to show during
FY09 and 1H FY10.
Interest spread (%)
Source: Companies, Daiwa forecasts
NIMs (%)
2.32
2.29
2.17
2.06
2.20
2.13
2.03 2.02
1.85
1.90
1.95
2.00
2.05
2.10
2.15
2.20
2.25
2.30
2.35
FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E
17
Thin product spread on standard variable home loans
Source: Companies, Daiwa estimates
The product spread of the Australia banks on standard variable mortgages has been under pressure as a result of a lack of re-
pricing. Westpac was the latest major bank to increase its mortgage rate outside of the official cash-rate change (in December 2009,
out-of-cycle increase of 20 basis points). Since then, the major banks have passed on only the 75 basis-point change in the official
cash rate. Australia’s current cash rate stands at 4.50% (since 5 May 2010). As a result of Westpac’s repricing, it has the highest
standard variable home loan rate of the major Australia banks. The margin pressure can also be illustrated by the product spread on
mortgage loans in Westpac’s book. Since 1H FY09, the product spread has contracted by 15 basis points.
The data underlines the importance of a strong proprietary channel in terms of mortgage origination. Banks with the lowest broker
/highest proprietary usage are: NAB (25/75%), Westpac (35/65%), CBA (36/64%) and ANZ (46/54%). This is the reason, we argue,
why NAB can afford to focus on a price-led, volume-driven, organic-growth strategy.
Pricing of standard variable home loans (%)
Source: Company
Product spread mortgage loans, WBC (%)
67 66
91
87
76
0
10
20
30
40
50
60
70
80
90
100
1H08 2H08 1H09 2H09 1H10
7.41 7.36 7.24
7.51
7.38
6.71 6.59
6.86
6.73
6.46 6.41 6.29
6.56
6.436.50
6.76
6.50 6.50 6.50 6.50
5.6
5.8
6.0
6.2
6.4
6.6
6.8
7.0
7.2
7.4
7.6
7.8
ANZ CBA NAB WBC Average
Headline rate
Net rate after discount/proprietary channel
Net rate after discount/broker channel
Three-year term deposit
18
ANZ
Source: Company
For ANZ, the NIM (excluding global markets) improved modestly in 3Q FY10 versus 1H FY10. According to ANZ, NIM growth is
slowing as a result of higher funding costs and intense competition (especially for deposits). The flow-through of re-pricing in New
Zealand and for the Institutional division, including product-mix changes, has had a positive impact.
On the NIM outlook, CEO Mike Smith said: ‘we still got a slightly increasing margin outlook. By the end of FY10, we will still have the
benefit of the lag coming through of the repriced assets.’ For FY11, ‘the trick will be actually trying to maintain the margin’ (ANZ, 3Q
FY10 trading update, 20 August 2010).
ANZ was the only major bank to record positive business loan growth in July 2010, while it has been relatively constrained in