Entering unchartered waters - Morgans
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Entering unchartered waters - Morgans
April 23, 2015 AUSTRALIA Notes from the Field Ashley Dalziell, CFA T 612 7903 2703 E [email protected] BS_150423 BANKS Entering unchartered waters We initiate coverage on the bank sector with a Neutral recommendation. While we recognise fundamental overvaluation, it is hard to envisage a near-term trigger for this to unwind. In this note we review recent sector drivers and highlight our expectations for the upcoming 1H15 reporting season. For the major banks that report in coming weeks, we forecast 1H15 growth of 3.0% for cash EPS and 4.4% for DPS on the pcp. ANZ is our preferred pick and only Add recommendation in the sector. Our sector preference order is ANZ (Add), CBA (Hold), NAB (Hold), and WBC (Hold). Sector overvalued, but near-term unwind unlikely Despite the recent correction, in our view the Australian bank sector remains fundamentally overvalued. That said, the banks are not alone in this regard, with the bank sector trading in line with its long run average relative to the non-bank industrials. On undoubtedly the key metric for the domestic equity market currently, the current sector yield of 5.0% still offers considerable pick-up relative to the 10-year AU bond rate and the 12-month system term deposit rate. Bank sector earnings growth prospects are not particularly attractive, and we forecast just 3.0% EPS growth on aggregate for the three banks reporting in coming weeks. Relative to domestic alternatives however, the resources sector is still firmly in a downgrade cycle, and broader industrials are still finding their feet. To this end, the sector continues to benefit from its relative earnings certainty. 1H15 reporting season expectations Key themes for this reporting season: 1) system volume has lifted on stronger mortgage and business lending activity; 2) we expect weaker margins in 1H15 (-4bps hoh) on pressure from mortgage and corporate spreads, free funds, low-cost deposits (offset gains from funding spreads and term deposits); 3) with a lift in volatility, markets income is likely to recover somewhat; 4) we expect stronger equities markets to help funds management, and no further deterioration in life insurance; 5) we look for strong cost control although software amortisation headwinds should continue to rise; 6) we expect a benign bad-debt outcome; and 7) we expect little management insight on new world regulation although do not expect DRP neutralisations in coming weeks. Neutral sector, ANZ preferred pick We initiate coverage on the sector with a Neutral recommendation. While we recognise fundamental overvaluation, it is hard to envisage a near-term trigger for this to unwind when we consider a likely later-than-expected lift in the US Fed funds rate, strong potential for near-term rate cuts domestically, further pressure in commodities (particularly those key for the Australian market) and a very tepid economic backdrop restraining industrial earnings. Our sector preference order is ANZ (Add), CBA (Hold), NAB (Hold), and WBC (Hold). IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (A.B.N. 49 010 669 726) AFSL 235410 A PARTICIPANT OF ASX GROUP. BANKS April 23, 2015 Entering unchartered waters Table of Contents SUMMARY AND CONCLUSIONS 1. SUMMARY AND CONCLUSIONS p.2 2. LONG-TERM TRENDS p.5 3. REVIEW OF SECTOR THEMES p.7 4. 1H15 REPORTING SEASON GUIDE p.16 5. COMPANY PROFILES p.18 Sector overvalued, but near-term unwind unlikely Despite the recent correction, in our view the Australian bank sector remains fundamentally overvalued on a P/NTA and P/E basis particularly given uncertainties regarding the regulatory outlook. To this end we recognise the current sector forward PE at 14.5x is now substantially above its long run average of 11.9x. That said the banks are not alone in this regard, with the S&P/ASX200 enjoying a particularly strong start to 2015, benefitting from a lower and flatter rate environment domestically, and expectations of a longer divergence in global interest rate settings than was expected in 2014. Figure 1: Bank sector PE (consensus 1 year forward) 17.0 16.0 Figure 2: Bank sector PE relative non-bank industrials PE 120% x Current: 82.5% Current: 14.5 Avg: 11.9 Expensive 110% 15.0 14.0 Avg: 82.6% Title: Source: Expensive 100% Please fill in the values above to have them entered in your rep 13.0 90% 12.0 11.0 80% 10.0 9.0 70% Cheap 8.0 7.0 Cheap 60% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: MORGANS, BLOOMBERG SOURCES: MORGANS, BLOOMBERG To this end, the bank sector PE relative to the non-bank industrials PE is trading in line with its long-term average. On undoubtedly the key metric for the domestic equity market currently, recent sector gains have driven the sector dividend yield to just 5.0% currently, which is below the long run average. On a relative basis however the banks still offer considerable pick-up relative to the 10-year AU bond rate and the 12-month system term deposit rate. Figure 3: Sector dividend yield Figure 4: Sector dividend yield vs AU 10yr bond yield & 12m term deposit rate 10% 10.0% Current: 5.0% Avg: 5.5% 9% Title: Source: 8% 9.0% 7% 8.0% Cheap 6% Please fill in the values above to have them entered in your rep 5% 7.0% 4% 3% 6.0% 2% 1% 5.0% Sector Yield 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: MORGANS, BLOOMBERG AU 10yr bond 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 Expensive 4.0% 1996 1995 0% Term deposit - 12m SOURCES: MORGANS, BLOOMBERG, RBA Bank sector earnings growth prospects are not particularly attractive, and we forecast just 3.0% EPS growth on aggregate for the three banks reporting in coming weeks. Relative to domestic alternatives however, the resources sector is still firmly in a downgrade cycle, and broader industrials are still finding their feet. To this end, the sector continues to benefit from its relative earnings certainty, although should the recent improvements in industrial earnings continue, it would pose a threat to current bank sector multiples. 2 BANKS April 23, 2015 Figure 5: FY16 consensus EPS revisions 110 105 100 95 90 85 80 75 70 Banks Industrials Apr-15 Mar-15 Feb-15 Jan-15 Dec-14 Nov-14 Oct-14 Sep-14 Aug-14 Jul-14 Jun-14 May-14 Apr-14 Mar-14 Feb-14 60 Jan-14 65 Resources SOURCES: MORGANS, BLOOMBERG We initiate on the sector with a Hold recommendation. While we recognise fundamental overvaluation, it is hard to envisage a near-term trigger for this to unwind when we consider a likely later-than-expected lift in the US Fed funds rate, strong potential for near-term rate cuts domestically, further pressure in commodities (particularly those key for the Australian market) and a very tepid economic backdrop restraining industrial earnings. Our sector preference order is ANZ (Add), CBA (Hold), NAB (Hold), and WBC (Hold) and we outline our investment views on each below. The reporting season guide in this report outlines our expectations for the upcoming reporting season. ANZ (Add, TP = A$38.85): ANZ is our preferred pick of the major banks. Within the sector ANZ offers valuation appeal trading at a 13% discount to the sector, at levels consistent with the GFC when ANZ’s commercial book was in melt down. We think many of the sources of ANZ’s 1Q15 revenue weakness will be temporary, and think management’s capacity and focus on cost management should support underlying earnings growth in the near term. Further, we think ANZ’s asset quality metrics have improved more than peers since the FY09-10 peak on a number of metrics with the risk profile of the commercial book now much improved. Recent China weakness is likely weighing on sentiment for ANZ, although we remain optimistic that ANZ can increase returns in its Asian business (driven by improvements to costs, margins and more broadly, an unwind of global macroeconomic settings, which have been a headwind for the business in recent years). CBA (Hold, TP = A$83.81): We still see sector trends becoming less favourable for CBA, as mortgage growth peaks, base interest rates fall, competition builds, and household income growth slows. However, we think its technology advantage over peers should leave it better prepared for this backdrop, and to take advantage of continued technologically led changes in banking. CBA will release its 3Q15 trading update on Wednesday, May 6th. NAB (Hold, TP = A$40.90): Since new management has begun to deliver on its commitment to boost returns for the group (largely through shedding non-core businesses), NAB has re-rated back toward its long run average 7% discount to the sector, after trading at a much steeper discount through much of 2014. After dealing with low hanging fruit, to drive further rerating we think management needs to demonstrate sustainable improvements in its core business banking franchise, and or achieve a decent outcome on fully exiting the UK. In the near term we remain concerned that further provisions for interest rate swap miss-selling may weigh on performance. We have a Hold rating on NAB and it is our #3 pick of the major banks. WBC (Hold, TP = A$36.80): WBC has performed reasonably well into its result, currently trading at a 5% premium to the sector, relative to its 1% long run average. We see WBC as expensive given a weaker-than-peer earnings growth trajectory, greater exposure to an inevitable recalibration 3 BANKS April 23, 2015 of mortgage capital calculations (WBC has the lowest mortgage risk weighted asset to exposures ratio in the sector), greater exposure to developments in macroprudential policy (given its east coast investor lending bias) and ongoing institutional pressure. We have a Hold recommendation and A$36.80 target price. WBC is our #4 preference of the major banks. Key 1H15 reporting season themes Volumes: ANZ has outperformed peers in total lending, driven by a solid performance across all consumer segments. NAB has added most share in household deposits while WBC outperformed in business deposits in 1H15. Margins: We expect a -4bp fall hoh in 1H15 as pressure on mortgage & corporate spreads and free funds are almost offset by gains on funding costs. Trading income: After a weak 2H14, trends were improved in 1Q15, which we expect carried over to 2Q15 on a lift in financial market volatility. Treasury earnings are difficult to judge given considerable movement in the domestic curve through the period. Wealth: Improved inflows and higher equities markets should help funds management. Pressure should remain on fees and we expect the worst has passed for life insurance. Costs: We expect productivity programmes and progress on IT investment to be under the microscope. Some further gains are likely from staffing, although IT amortisation headwinds will continue to increase. Bad debts: We expect another benign bad-debts outcome, consistent with further improvements noted in 1Q15 Pillar-three reports. Capital: All focus will be on management commentary regarding the next wave of regulation. We expect no DRP neutralisations in coming weeks. Valuation and risks We arrive at our valuations for the major banks using a blend of DCF, price to earnings, price to underlying earnings and price to NTA. We set out our target prices at a premium to our valuations to take account of the current divergence between the bank sector yield and the 10-year bond rate. Risks to our target prices being achieved are a faster-than-expected lift in domestic rates and a tougher-than-expected new world regulatory outcome. 4 BANKS April 23, 2015 LONG-TERM TRENDS Sector analysis – absolute Following this month’s sell-off, the bank sector PE is still expensive relative to the long run average Figure 6: PE – absolute 16.0 Current: 14.5 Avg: 11.9 x 14.0 12.0 10.0 8.0 6.0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS The global hunt for yield has been a large driver of the rally in domestic banks in recent years Figure 7: Dividend yield – absolute Current: 5.0% Avg: 5.5% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS On our underlying earnings assumptions, the sector is trading well above one standard deviation expensive Figure 8: Price to underlying EPS – absolute 10.0 Current: 9.2 Avg: 7.1 x 9.0 8.0 7.0 6.0 5.0 4.0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS The sector is now trading at 2.8x on a P/NTA basis, which is above the long run average of 2.6x Figure 9: Price to NTA – absolute 4.0 Current: 2.8 Avg: 2.6 x 3.5 With additional regulatory capital requirements likely to weigh on returns in the near term, the sector is likely to trade below this long run average for the foreseeable future 3.0 2.5 2.0 1.5 1.0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 SOURCES: BLOOMBERG, IRESS, MORGANS 5 BANKS April 23, 2015 Sector analysis – relative Figure 10: PE vs market On a relative basis, the bank sector PE is trading closer to long run averages relative to the PE for the broader S&P/ASX200 Current: 87.0% Avg: 83.8% 130% 120% 110% 100% 90% 80% 70% 60% 50% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS Relative to non-bank industrials (ignoring weakness in resources stocks) the bank sector is trading slightly below its long run average Figure 11: PE vs non-bank industrials Current: 82.5% Avg: 82.6% 120% 110% 100% 90% 80% 70% 60% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS Compared to the 10-year bond yield, the sector’s dividend yield is still trading over one standard deviation cheap This breakdown in the trend between dividend and bond yields has been experienced across the market Figure 12: Sector dividend yield vs 10 year bond yield Current: 212.1% Avg: 107.6% 260% 210% 160% 110% 60% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS From an earnings yield perspective, the sector is also trading more than one standard deviation cheap Figure 13: Sector earnings yield vs 10-year bond yield Current: 292.2% Avg: 163.4% 350% 300% 250% 200% 150% 100% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: BLOOMBERG, IRESS, MORGANS 6 BANKS April 23, 2015 REVIEW OF SECTOR THEMES Volumes RBA system lending growth in the 12 months to February 2015 was 6.2%, comprising 7.2% for housing, 5.6% for business and 0.5% for personal. System growth in bank deposits was 7.9% over the same period. Figure 14: System credit growth tracking at 6.2% yoy in 12 months to Feb-15 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% 77 79 81 83 85 87 89 91 Housing 93 95 Personal 97 99 01 Business 03 05 07 09 11 13 Total SOURCES: MORGANS, RBA Within the mortgage segment, despite very strong levels of activity, mortgage pre-payments also remain elevated, keeping the recent recovery in overall mortgage credit growth relatively contained. With the growth in mortgage approvals having now peaked and APRA’s recent efforts to curb investor loan growth, even with the expectation of further rate cuts, we expect mortgage credit growth is likely to be peaking around current levels. The broker channel has been key in delivering growth in recent periods, supporting MQG’s aggressive move into the mortgage segment. Figure 16: Mortgage finance approvals – growth yoy (value) Figure 15: Move in mortgage market share (12m to Feb-15) 50% 0.4% Title: Source: 40% 0.3% 30% Figure 17: Broker channel driving growth – FY14 Title: Source: Please fill in the values above to have them entered in your Please report fill in the values above to h 0.2% 20% 0.1% 10% 0.0% 0% -0.1% -10% -0.2% -20% -0.3% -30% MQG NAB ANZ Rabo SUN BEN BOQ WBC CBA ING -40% -0.4% 06 07 08 09 10 11 Owner occupied SOURCES: MORGANS, APRA 12 13 14 15 Investor SOURCES: MORGANS, ABS SOURCES: CBA While the headline improvement in business lending growth (+5.6% yoy) is positive (particularly considering the uncertain economic backdrop), when including activity in the corporate bond market for a more complete picture of business credit growth, the picture is less cheerful (+3.7% yoy). Commercial finance commitments, which are a strong lead indicator for near-term performance in business credit growth, are now also beginning to roll over, after a period of strong readings. 7 BANKS April 23, 2015 Figure 18: Move in business lending market share (12m to Feb-15) Figure 19: Total business credit growth 30% 0.8% 60% Title: Source: 25% 0.6% Figure 20: Commercial finance approvals Title: Source: 50% 40% 20% Please fill in the values above to have them entered in your Please report fill in the values above to h 0.4% 30% 15% 20% 0.2% 10% 0.0% 5% 0% 0% -10% 10% -0.2% -20% -5% -0.4% -30% -10% -40% 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 Business lending Corporate bonds Total business credit (incl bonds) WBC BEN ING BOQ MQG ANZ SUN CBA NAB -0.6% Rabo 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 SOURCES: MORGANS, APRA 3m moving avg - net 12m moving avg - net SOURCES: MORGANS, ABS, RBA SOURCES: MORGANS, ABS At the system level, deposit growth continues to outstrip loan growth, although the gap remains much narrower than in recent years. With sector funding composition now much improved, we believe the major banks are much more comfortable with current loan-to-deposit ratios, which has driven a corresponding reduction in deposit competition. Figure 21: Move in total deposits market share (12m to Feb-15) Figure 22: Deposit growth vs lending 90% 25% 0.5% Figure 23: Customer deposits to loans Title: Source: yoy grow th 0.4% 80% Title: Source: 76.6% 72.8% 20% 0.3% 71.7% 70.1% 70% to have them entered in your Please fill in the values above Please report fill in the values above to h 0.2% 15% 60% 0.1% 50% 10% 0.0% 40% -0.1% 5% -0.2% 30% -0.3% 0% CBA MQG WBC BEN Rabo SUN BOQ NAB ANZ ING 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 -0.4% Deposit growth - Broad money Australian Total Lending - total SOURCES: MORGANS, APRA SOURCES: MORGANS, ABS 20% ANZ FY06 FY12 FY07 FY13 CBA FY08 1H14 NAB FY09 2H14 WBC FY10 1H15 FY11 SOURCES: MORGANS, COMPANY REPORTS Margins We expect net interest margins to fall by an average of 4bp sequentially for the three major banks reporting in coming weeks with risks still skewed to the downside for sector margins. 8 BANKS April 23, 2015 Figure 24: Housing loans – SVR Figure 26: Term deposits – special rate Figure 25: Online saver accounts 1.0% 4.0% 0.8% 3.5% Title: Source: 0.5% Please fill in the values above to have them entered in your report 0.6% 3.0% 1.0% Title: Source: Please fill in the values above to have them entere 0.0% 0.4% 2.5% -0.5% 0.2% 2.0% 0.0% -1.0% 1.5% -0.2% 1.0% -1.5% -0.4% 0.5% -0.6% -2.0% 06 0.0% 06 07 • 08 09 10 11 12 13 14 15 SOURCES: MORGANS, RBA, IRESS -0.8% 06 07 •08 09 10 11 12 13 14 15 SOURCES: MORGANS, RBA, IRESS 07 • 08 09 Spot 10 11 12 13 14 15 Portfolio average SOURCES: MORGANS, RBA, IRESS Lending competition across all segments remains well documented. While headline mortgage spreads remain attractive, behind-the-scenes competition remains elevated, with aggressive discounting ongoing, very competitive fixed rate offers and further growth in the broker channel (more likely to attract discounts). To this end, longstanding business lending pressure has increasingly spread into mortgages over recent periods, highlighted by the decline in CBA’s Retail Banking Services divisional NIM in 1H15. Institutional lending spreads look to be stabilising somewhat after a two-year decline, although this segment remains particularly competitive, fuelled by cheap offshore liquidity. Spreads on small business lending are higher, but remain under pressure. On the liability side of the balance sheet we expect the picture will be more favourable and improvements should go some way to offsetting asset pressure. More broadly we note: We expect the sector will continue to benefit from the mix shift from term deposits into more flexible (and profitable) transaction and online accounts (as highlighted by CBA’s RBS result in 1H15). The improvement in term-deposit spreads has continued in recent months for “specials” although system six- and 12-month spot spreads have stopped improving. Spreads on transaction accounts and online saver products have deteriorated however, and we would expect the contribution from hedging (replicating portfolios) will continue to fade for the former. Despite this drag, these products are still more profitable than term deposits, and any further mix shift will be beneficial. 9 BANKS April 23, 2015 Figure 27: Average cost of wholesale funding (CBA 1H15) Figure 28: CBA - RBS deposit mix 100% 14% 14% 14% 13% 12% 11% 12% 11% 11% 10% 11% 12% 46% 47% 48% 51% 51% 52% 53% 52% 50% 47% 45% 48% 18% 19% 15% 15% 15% 18% 18% 21% 19% 18% 24% 18% 20% 19% 19% 22% 20% 22% 22% 24% 25% 17% 11% 80% 60% 40% 23% 41% 21% 20% 14% 27% 0% 1H09 On-line SOURCES: CBA 1H10 1H11 Savings deposits 1H12 Term deposits 1H13 1H14 1H15 Transaction accounts SOURCES: MORGANS, COMPANY REPORTS Wholesale funding spreads have remained stable at low levels over the past six months, although with limited asset growth wholesale balances have remained flat and lower rates will take some time to work through the book. We expect a small benefit to group margins in 1H15 for the sector. Finally we expect free-fund earnings will remain under pressure despite ongoing capital build. The squeeze on free-fund earnings in the low-rate environment has been a headwind in recent periods. We believe the best general indicator of investment income on these funds is the three-year bond yield, as the term for free funds investment is in the two- to five-year term range. With the rapid flattening of the curve experienced in recent months, both the spot and rolling outcome here will be negative for the sector. Non-interest income Trading income / markets We expect trading income results to improve in upcoming 1H15 results. There is typically some seasonal weakness in second half performance, and we expect the uplift in volatility from late 2014 (following a number of months of historically low market volatility) will drive a lift in client activity. Balance sheet, or treasury income may display some volatility given the rapid change in market cash rate estimates earlier in the year, and broader curve flattening. CBA spoke to a number of these trends in its recent 1H15 result. Trading income rebounded 24% on the prior period with strong sales and trading results within the Markets business, and a positive counterparty fair value adjustment (CVA) mark. We note WBC’s recent derivative accounting change will weigh on the group’s trading result in 1H15, with a one-off A$125m pre-tax revenue impact expected. 10 BANKS April 23, 2015 Figure 30: CVA – impact on earnings in recent periods Figure 29: CBA net trading income (A$m) 100 A$m 75 50 25 0 n/a -25 -50 -75 ANZ CBA 1H13 2H13 NAB 1H14 SOURCES: MORGANS, APRA, RBA, COMPANY REPORTS 2H14 WBC 1H15 SOURCES: MORGANS, COMPANY REPORTS Wealth Wealth performance should be reasonably solid. Relative to 2H14, equity markets have risen strongly in 2015 while equity inflows have also been strong in the half. This suggests that earnings in the funds management arm of the banks’ wealth management units should be solid. In life insurance, we expect the market has bottomed, but the turnaround could be gradual, and we think the ‘irrational oligopoly’ structure of the life insurance sector dampens the scope for a quick return to profitability. NAB and ANZ both flagged at their recent 1Q15 trading updates that their Wealth divisions had benefitted from stable claims and lapses. This suggests there is little or no extra reserving likely in 1H15. Figure 31: Life insurance – experience results (A$m) 40 20 0 -20 -40 -60 -80 -100 -120 ANZ CBA 1H11 2H11 1H12 NAB 2H12 1H13 AMP 2H13 1H14 2H14 SUN 1H15 SOURCES: MORGANS, COMPANY REPORTS Expenses The prospect of a structural slowdown in revenue growth increases the reliance on efficiency gains to grow earnings. However, this coincides with the need for greater investment in IT to ‘stay in business’. To this end, much of this IT spend will be deferred and capitalised on the balance sheet, and deferred software balances are still rising across the sector (we note NAB’s 2H14 result was flattered by software writedowns). The resulting increase in software amortisation is now becoming a much larger headwind for the sector. 11 BANKS April 23, 2015 We think the banks' main challenge on cost management is to find enough productivity gains to offset the growth in IT amortisation. This is a difficult task considering greater compliance and regulatory costs associated with seemingly never ending ‘new world’ regulatory burden, inflation-related salary increases and less easy gains on staffing (Figure 35). Figure 32: Deferred software balance Figure 33: Software amortisation charge 300 2500 A$m Figure 34: Average FTEs, 1H11=100 110 A$m Title: Source: 250 Title: Source: 105 2000 Please fill in the values above to have them entered in your Please report fill in the values above to h 200 100 1500 150 95 100 90 50 85 1000 500 0 0 ANZ 1H07 1H10 1H13 2H07 2H10 2H13 CBA 1H08 1H11 1H14 NAB 2H08 2H11 2H14 WBC 1H09 1H12 1H15 2H09 2H12 SOURCES: MORGANS, COMPANY REPORTS 1H07 1H10 1H13 ANZ 2H07 2H10 2H13 CBA 1H08 1H11 1H14 NAB 2H08 1H09 2H11 1H12 2H14 1H15 WBC 2H09 2H12 SOURCES: MORGANS, COMPANY REPORTS 80 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 ANZ CBA NAB WBC SOURCES: MORGANS, COMPANY REPORTS At ANZ and NAB, much of the scope to reduce expenses lies in the offshore units. In 2H14, the cost-to-income ratio in NAB's UK Banking unit and ANZ's Asia Pacific Europe and America regions was excessive at 70.8% and 56.0%, respectively. WBC's group 2H14 cost-to-income ratio of 42.0% is the lowest of the big four banks and it has less potential for easy cost gains than peers, in our view. WBC has recently outlined plans for a 'phase II' IT investment strategy to follow the 'phase I' investment over FY09-14, which included the strategic investment priorities (SIPs). Phase II will aim to refresh the bank's key processing systems to build on the Phase I investments on front-end customer facing systems, which is likely to keep pressure on costs, and see the deferred software balance creep higher. Asset quality We expect another solid asset-quality result in 1H15, with ANZ, NAB and WBC likely to print a bad-debt charge below the market’s assessment of mid-cycle bad debts. To this end we expect the bad-debt charge to total loans ratio to rise 2bps on average in 1H15 compared to 2H14, and remain below banks’ FY06-12 average (the incurred loss basis provisioning period). Gross impaired assets were on average down 12% for ANZ, NAB and WBC in 1Q15 on 2H14 levels, though this was largely driven by a strong outcome at NAB (which was driven by UK CRE runoff) with flat outcomes at ANZ and WBC. In 1H15 CBA’s ratio of impaired assets/non-housing loans continued to fall (albeit at a slower rate, and the level of new impaired loans also continued to decline). However, with a number of key industries subject to structural change, we remain cautious and will look to monitor outlook statements and watchlist trends for any early warning sign of asset-quality deterioration. Low interest rates and only modest rises in the unemployment rate suggest retail and credit-card arrears should be well contained in 1H15. 12 BANKS April 23, 2015 Figure 35: Gross impaired assets/non-housing loans Figure 36: New & increased impaired assets/non-housing loans 4.0% 3.0% Title: Source: 3.5% 2.5% Please fill in the values above to have them entered in your report 3.0% 2.0% 2.5% 2.0% 1.5% 1.78% 1.56% 1.18% 1.09% 1.5% 1.21% 1.14% 0.93% 1.0% 0.66% 1.0% 0.5% 0.5% 0.0% 0.0% ANZ FY07 CBA FY08 FY09 FY10 NAB FY11 FY12 ANZ WBC FY13 FY14 2H10 1H15 1H11 CBA 2H11 1H12 NAB 2H12 SOURCES: MORGANS, COMPANY REPORTS 1H13 2H13 WBC 1H14 2H14 1H15 SOURCES: MORGANS, COMPANY REPORTS The anticipated fall in impaired assets will likely tempt banks (and auditors) to boost earnings by releasing collective provision overlays, although we expect only minor releases, if any, and note banks will now be in preparation for new expected loss accounting changes. CBA and WBC continue to lead peers on provisioning coverage. Figure 37: Bad debt charge/non-housing loans Figure 38: Collective provision/non-housing loans 2.0% 2.0% 1.8% 1.8% 1.6% 1.6% 1.4% 1.4% 1.2% 1.2% 1.0% 1.0% 0.8% 0.8% 0.6% Title: Source: Please fill in the values above to have them entered in your report 1.35% 1.29% 1.14% 1.08% 0.6% 0.41% 0.40% 0.4% 0.37% 0.35% 0.4% 0.2% 0.2% 0.0% ANZ FY07 FY08 CBA FY09 FY10 NAB FY11 FY12 FY13 0.0% WBC FY14 ANZ FY07 1H15 SOURCES: MORGANS, COMPANY REPORTS FY08 CBA FY09 FY10 NAB FY11 FY12 FY13 WBC FY14 1H15 SOURCES: MORGANS, COMPANY REPORTS Capital / regulation CBA’s Basel 3 common equity Tier 1 (CET1) ratio was 9.2% in 1H15, down from 9.3% in 2H14. On a post-dividend basis, CBA’s CET1 would fall to 8.60%, which is similar to the 8.63-8.97% range of peers at their 2H14 balance dates. The need to rebuild capital is the main reason why CBA decided not to neutralise its 1H15 dividend reinvestment plan. 13 BANKS April 23, 2015 Figure 39: Last reported CET1 ratios 9.30% 9.20% 9.10% 9.00% 8.90% 8.80% 8.70% 8.60% 8.50% 8.40% 8.30% 9.23% 8.97% 8.79% 8.63% ANZ CBA NAB WBC SOURCES: MORGANS, COMPANY REPORTS After a particularly busy end to 2014, the capital and regulatory discussion has been quieter in 2015 to date. The post report consultation period for the Murray report / Financial Services Inquiry has now closed (March-31), and the government will look to pass judgement on the report’s recommendations in coming weeks. We doubt the banks will be able to block the Inquiry’s capital proposals. It is widely expected that most recommendations will be supported by the government; however, APRA has flagged that it is in no rush to release new regulation. On the two key recommendations for the bank sector (listed below) APRA has suggested it is in no rush to launch new regulation. Given continual developments on these issues offshore, APRA believes there is no merit in moving ahead of international regulatory bodies, and is hoping to gain greater colour on the international direction before implementing new regulation domestically. Lift core equity capital relative to global peers to >75th percentile from the current ~60th percentile; and Increase capital against their mortgage books to 25-30% of exposures from the current 14-19%. Mortgage capital requirements Murray’s desire to lift mortgage capital is not an Australian-centric issue, and the degree of international momentum behind this issue suggests changes are inevitable, and may be introduced before APRA gives more guidance as to broader group target CET1 ratios. The Basel committee has flagged concern over inconsistencies and not enough conservatism amongst Advanced-IRB bank mortgage capital calculations globally. To this end, at the G20 the BSBC stressed it will aim to improve these issues, and will release a Consultation Paper in mid-2015, and final recommendations from the assessment are expected by end-2015. While the report does not recommend a preferred method to boost mortgage RWA, the three most likely options APRA will review in lifting mortgage RWAs will be floors, the correlation factor, and it may look to align its more relaxed treatment of investor loans with the Basel standard. Moving to a 27.5% risk weight for mortgages, and assuming a 10.00% headline CET1, would equate to an increased CET1 in the 0.80- 1.7% range. Capital targets Murray’s recommendation regarding broader group target capital ratios supports our view that Australia’s banks will be more closely tied to the global trend to increase capital levels. In our view, global bank capital levels will keep rising, and Australian banks will be dragged higher. We expect that major bank target CET1 ratios will ultimately settle in the 10-11% range, regardless of whether APRA looks to drive this increase through a larger D-SIB buffer, tougher leverage ratio requirement or more stringent TLAC (total loss absorbing capacity) requirements. 14 BANKS April 23, 2015 Near-term impact We expect seemingly never ending regulation will result in a prolonged period of capital build for the sector, diminishing any hopes of near-term capital management. That said, as highlighted above, APRA is unlikely to enact new regulation for some time, and new requirements will be met with very reasonable implementation timeframes. While the headline capital shortfall will be material for the sector (potentially upwards of A$10bn for each bank), organic capital generation and dividend settings (underwritten DRPs) are likely to be sufficient, and the market’s original concern of imminent capital raisings have eased. 15 BANKS April 23, 2015 1H15 REPORTING SEASON GUIDE Key reporting season themes Volumes: ANZ has outperformed peers in total lending, driven by a solid performance across all consumer segments. NAB has added most share in household deposits while WBC outperformed in business deposits in 1H15. Margins: We expect a -4bp fall hoh in 1H15 as pressure on mortgage & corporate spreads and free funds are almost offset by gains on funding costs. Trading income: After a weak 2H14, trends were improved in 1Q15, which we expect carried over to 2Q15 on a lift in financial market volatility. Treasury earnings are difficult to judge given considerable movement in the domestic curve through the period. Wealth: Improved inflows and higher equities markets should help funds management. Pressure should remain on fees and we expect the worst has passed for life insurance. Costs: We expect productivity programmes and progress on IT investment to be under the microscope. Some further gains are likely from staffing, although IT amortisation headwinds will continue to increase. Bad debts: We expect another benign bad-debts outcome, consistent with further improvements noted in 1Q15 Pillar-three reports. Capital: All focus will be on management commentary regarding the next wave of regulation. We expect no DRP neutralisations in coming weeks. We highlight our expectations and result day focus for each bank in the following pages. 16 BANKS April 23, 2015 Figure 40: 1H15 results cheat sheet (A$m) 1H14A Summary profit and loss Average interest earnings assets Net interest margin Net interest income Non-interest income Total revenue Operating expenses Underlying earnings Bad debt expense Pre-tax earnings Tax expense OEIs Preference dividends Cash earnings Non-cash adjustments Reported earnings Cash earnings per share (c) - basic Dividends per share (c) ANZ - May 5th 1H15F / 2H14A 1H15F 1H14A NAB - May 7th 1H15F / 2H14A 1H14A 2H14A WBC - May 4 1H15F 1H15F / 1H14A 1H15F / 2H14A 1H14A 2H14A 1H15F 1H15F / 1H14A 1H15F / 2H14A 632,400 2.15% 6,764 2,905 9,669 -4,286 5,383 -529 4,854 -1,333 -6 -3 3,512 -120 3,392 129.3 83.0 661,515 2.12% 7,033 2,879 9,912 -4,474 5,438 -463 4,975 -1,367 -6 -3 3,599 280 3,879 132.1 95.0 695,176 2.05% 7,114 2,984 10,097 -4,538 5,560 -486 5,074 -1,395 -6 -3 3,669 3 3,672 134.1 87.0 9.9% -4.3% 5.2% 2.7% 4.4% 5.9% 3.3% -8.1% 4.5% 4.7% 0.0% 0.0% 4.5% -102.5% 8.3% 3.7% 4.8% 5.1% -3.2% 1.1% 3.6% 1.9% 1.4% 2.2% 5.0% 2.0% 2.1% 0.0% 0.0% 2.0% -98.9% -5.3% 1.5% -8.4% 707,170 1.94% 6,843 2,644 9,487 -4,456 5,031 -528 4,503 -1,263 0 -90 3,150 -294 2,856 134.1 99.0 715,993 1.93% 6,932 2,494 9,426 -5,724 3,702 -349 3,353 -1,229 0 -90 2,034 405 2,439 86.2 99.0 742,444 1.91% 7,081 2,697 9,778 -4,563 5,215 -422 4,792 -1,342 0 -90 3,360 90 3,450 140.6 104.0 5.0% -1.4% 3.5% 2.0% 3.1% 2.4% 3.6% -20.0% 6.4% 6.2% n.a. 0.0% 6.7% -130.6% 20.8% 4.9% 5.1% 3.7% -1.0% 2.1% 8.1% 3.7% -20.3% 40.9% 21.0% 42.9% 9.2% n.a. 0.0% 65.2% -77.8% 41.5% 63.1% 5.1% 635,657 2.11% 6,677 3,182 9,859 -4,065 5,794 -341 5,453 -1,643 -38 0 3,772 -150 3,622 121.3 90.0 659,003 2.06% 6,819 3,142 9,961 -4,181 5,780 -309 5,471 -1,587 -28 0 3,856 83 3,939 124.0 92.0 685,560 2.04% 6,973 3,158 10,131 -4,267 5,864 -405 5,459 -1,638 -28 0 3,793 0 3,793 121.7 93.0 7.9% -3.2% 4.4% -0.7% 2.8% 5.0% 1.2% 18.7% 0.1% -0.3% -26.3% n.a. 0.6% -100.0% 4.7% 0.3% 3.3% 4.0% -1.2% 2.3% 0.5% 1.7% 2.1% 1.4% 31.0% -0.2% 3.2% 0.0% n.a. -1.6% -100.0% -3.7% -1.9% 1.1% 15.5% 2.01% 44.3% 27.5% 15.4% 1.99% 45.1% 27.5% 14.9% 1.95% 44.9% 27.5% -0.7% -0.06% 0.6% 0.0% -0.5% -0.03% -0.2% 0.0% 15.1% 1.73% 47.0% 28.0% 9.4% 1.10% 60.7% 36.7% 14.9% 1.79% 46.7% 28.0% -0.2% 0.05% -0.3% 0.0% 5.5% 0.68% -14.1% -8.7% 16.5% 2.40% 41.2% 30.1% 16.3% 2.35% 42.0% 29.0% 15.6% 2.24% 42.1% 30.0% -0.8% -0.16% 0.9% -0.1% -0.7% -0.12% 0.1% 1.0% 0.2% 1.4% 1.1% 43.6% 1.1% 1.7% 0.2% 1.1% 0.9% 42.8% 1.1% 1.5% 0.2% 1.0% 0.8% 42.3% 1.0% 1.4% 0.0% -0.4% -0.3% -1.3% -0.1% -0.3% 0.0% -0.1% -0.1% -0.5% -0.1% -0.1% 0.2% 2.4% 1.5% 34.8% 1.2% 2.1% 0.1% 1.8% 1.2% 35.3% 1.1% 1.8% 0.2% 1.4% 1.0% 35.3% 1.4% 1.9% 0.0% -1.0% -0.6% 0.5% 0.1% -0.2% 0.0% -0.3% -0.2% 0.0% 0.2% 0.1% 0.1% 1.5% 0.9% 39.4% 1.4% 2.0% 0.1% 1.2% 0.8% 37.1% 1.3% 1.8% 0.1% 1.1% 0.8% 35.9% 1.3% 1.7% 0.0% -0.4% -0.2% -3.4% -0.1% -0.3% 0.0% -0.1% 0.0% -1.1% -0.1% -0.1% 115.5% 8.3% 10.3% 64.2% 115.4% 8.8% 10.7% 71.9% 113.6% 9.0% 10.7% 64.9% -1.8% 0.7% 0.4% 0.7% -1.8% 0.2% 0.1% -7.0% 121.3% 8.6% 10.8% 73.8% 118.9% 8.6% 10.8% 114.8% 118.5% 9.1% 11.2% 74.0% -2.7% 0.5% 0.4% 0.1% -0.4% 0.5% 0.4% -40.9% 129.9% 8.8% 10.3% 74.2% 126.6% 9.0% 10.6% 74.2% 125.5% 9.1% 10.6% 76.4% -4.4% 0.3% 0.3% 2.3% -1.1% 0.1% 0.0% 2.3% Ratio analysis Profitability Return on equity (cash) Return on risk weighted assets (cash) Cost-to-income ratio Tax rate Asset quality BDDs / total loans Impaired assets / non-housing loans Problem loans / total loans Individual provisions / impaired assets Collective provisions / non-housing loans Total provisions / non-housing loans Balance sheet / capital Loan / deposit ratio Core tier 1 ratio Tier 1 ratio Dividend payout ratio SOURCES: MORGANS FORECASTS, COMPANY REPORTS 17 BANKS April 23, 2015 WBC – HOLD (TARGET PRICE A$36.80) WBC reports on Monday, 4 May. We forecast 1H15 cash earnings growth of 0.6% on the pcp to A$3,793m (1H14A A$3,772m), cash EPS (basic) of 121.7c (121.3c) and interim DPS of 93c (90c). Figure 41: WBC – 1H15 result estimates Summary profit and loss Average interest earnings assets Net interest margin Net interest income Non-interest income Total revenue Operating expenses Underlying earnings Bad debt expense Pre-tax earnings Tax expense OEIs Preference dividends Cash earnings Non-cash adjustments Reported earnings Cash earnings per share (c) - basic Dividends per share (c) 1H14A 2H14A 1H15F 1H15F / 1H14A 1H15F / 2H14A FY14A FY15F FY15F / FY14A 635,657 2.11% 6,677 3,182 9,859 -4,065 5,794 -341 5,453 -1,643 -38 0 3,772 -150 3,622 121.3 90.0 659,003 2.06% 6,819 3,142 9,961 -4,181 5,780 -309 5,471 -1,587 -28 0 3,856 83 3,939 124.0 92.0 685,560 2.04% 6,973 3,158 10,131 -4,267 5,864 -405 5,459 -1,638 -28 0 3,793 0 3,793 121.7 93.0 7.9% -3.2% 4.4% -0.7% 2.8% 5.0% 1.2% 18.7% 0.1% -0.3% -26.3% n.a. 0.6% -100.0% 4.7% 0.3% 3.3% 4.0% -1.2% 2.3% 0.5% 1.7% 2.1% 1.4% 31.0% -0.2% 3.2% 0.0% n.a. -1.6% -100.0% -3.7% -1.9% 1.1% 647,330 2.08% 13,496 6,324 19,820 -8,246 11,574 -650 10,924 -3,230 -66 0 7,628 -67 7,561 245.4 182.0 700,042 2.03% 14,229 6,643 20,872 -8,667 12,205 -916 11,289 -3,387 -56 0 7,846 0 7,846 251.0 189.0 8.1% -2.5% 5.4% 5.0% 5.3% 5.1% 5.5% 41.0% 3.3% 4.8% -15.2% n.a. 2.9% -100.0% 3.8% 2.3% 3.8% SOURCES: MORGANS FORECASTS, COMPANY REPORTS Result day focus Accounting change weighs on 1H15 earnings: At its 1Q15 update WBC flagged an accounting change relating to derivative valuation, which will have a one-off negative impact of A$125m (pre-tax) on 1H15 revenues (will reduce trading income). Asset quality: While we expect a strong asset quality outcome from WBC, we doubt it can repeat the 11bps/total loans result achieved in 2H14 (we forecast 14bps of total loans in 1H15). Impaired assets were flat into 1Q15 and we note that in 2H14, write-backs of previous provisions reduced WBC’s bad-debt charge by almost 40%. This is unsustainable in the long term. Capital: We expect WBC’s 1H15 CET1 ratio to be broadly flat on 2H14 levels with strong RWA growth evident in 1Q15. While business lending growth has been reasonable for WBC, the group has implemented a new mortgage RWA model in the period, which will weigh on capital. Investment view WBC has performed reasonably well into its result, currently trading at a 5% premium to the sector, relative to its 1% long run average. We see WBC as expensive given a weaker-than-peer earnings growth trajectory, greater exposure to an inevitable recalibration of mortgage capital calculations (WBC has the lowest mortgage risk weighted asset to exposures ratio in the sector), greater exposure to developments in macroprudential policy (given its east coast investor lending bias) and ongoing institutional pressure. We have a Hold recommendation and A$36.80 target price. WBC is our #4 preference of the major banks. 18 BANKS April 23, 2015 Figure 42: WBC – financial summary Company: ASX code Westpac Banking Group WBC Profit & loss (A$m) Recommendation Hold Average IEA Bloomberg code WBC AU Terminal year FY19F Margin (%) Reuters code WBC.AX Valuation date Mar-16 Net Interest income Valuation $33.42 Price target $36.80 Upside/(downside) Implied cash PE Share price No. of shares (m) Market cap (A$m) Year end $38.18 3,120 119,128 Sep FY13A FY14A FY15F FY16F FY17F 599,846 647,330 700,042 744,365 782,931 2.15 2.08 2.03 2.00 1.97 12,912 13,496 14,229 14,883 15,432 Lending fees 1,253 1,329 1,459 1,537 1,623 Non-lending fees 1,470 1,597 1,638 1,691 1,777 -3.6% Trading income 1,069 1,017 1,145 1,224 1,293 13.8x Wealth management income 1,521 1,731 1,847 2,038 2,250 Life insurance income 437 525 555 612 675 Other income 171 125 -1 132 138 18,833 19,820 20,872 22,116 23,190 Forecast summary FY13A FY14A FY15F FY16F FY17F Total income Reported PTP (A$m) 10,227 10,924 11,289 11,922 12,338 Expenses -7,759 -8,246 -8,667 -9,075 -9,471 6.8 3.3 5.6 3.5 Underlying Profit 11,074 11,574 12,205 13,041 13,719 6,751 7,561 7,846 8,289 8,580 Net write-offs -1,323 -1,302 -795 -932 -1,154 212 238 245 256 262 Movement in provisions 476 652 -121 -188 -227 12.2 11.9 3.0 4.4 2.4 Underlying earnings 10,227 10,924 11,289 11,922 12,338 7,063 7,628 7,846 8,289 8,580 Taxation -3,088 -3,230 -3,387 -3,576 -3,701 222 240 245 256 262 Minorities -76 -66 -56 -56 -56 6.4 8.0 2.1 4.4 2.4 Preference dividends 0 0 0 0 0 357 372 390 413 430 Cash earnings 7,063 7,628 7,846 8,289 8,580 Book value per share (c) 1,504 1,559 1,658 1,739 1,826 Non-recurring items 0 NTA per share (c) 1,109 1,157 1,261 1,346 1,436 Non-cash items 174 182 189 197 202 Reported net profit 4.8 4.6 3.8 4.2 2.5 Dilutive adjustments growth Reported net profit (A$m) Reported EPS (c) growth Cash earnings (A$m) Cash EPS (c) growth Underlying EPS (c) Dividend per share (c) growth 7.8 Diluted shares on issue Valuation summary 0 0 0 0 -312 -67 0 0 0 6,751 7,561 7,846 8,289 8,580 159 165 178 178 178 3,254 3,250 3,277 3,311 3,343 262 FY13A FY14A FY15F FY16F FY17F Cash eps (c) 222 240 245 256 Price / earnings 17.2x 15.9x 15.6x 14.9x 14.6x Cash eps growth (%) 6.4 8.0 2.1 4.4 2.4 Price / underlying earnings 10.7x 10.3x 9.8x 9.2x 8.9x Cash eps (c) - basic 228 245 251 262 269 Price / net tangible assets 3.4x 3.3x 3.0x 2.8x 2.7x Dividends per share (c) 174 182 189 197 202 4.6 4.8 5.0 5.2 5.3 21.9 22.4 21.2 20.6 19.8 Dividend yield (%) ROTE (%) Ratio analysis (%) FY13A FY14A FY15F FY16F FY17F Profitability Balance sheet (A$m) FY13A FY14A FY15F FY16F FY17F AU housing lending 328,532 351,037 375,461 394,783 414,077 AU business lending 126,429 137,016 148,331 158,989 170,414 AU personal lending 19,183 23,202 23,422 23,705 24,134 474,144 511,255 547,214 577,478 608,625 7.8 7.0 5.5 5.4 356,880 383,130 410,077 432,757 456,098 55,585 58,470 66,319 69,560 72,959 5.2 13.4 4.9 4.9 ROE (reported) 15.2 16.3 15.8 15.7 15.3 ROE (cash) 15.9 16.4 15.8 15.7 15.3 ROTE (cash) 21.9 22.4 21.2 20.6 19.8 RORWA (cash) 2.3 2.4 2.3 2.2 2.2 NZ lending ROA (cash) 1.0 1.0 1.0 1.0 1.0 growth ROTA (cash) 1.0 1.1 1.0 1.0 1.0 Non-int. income / income 31.4 31.9 31.8 32.7 33.5 Cost-to-income ratio 41.2 41.6 41.5 41.0 40.8 Revenue less cost growth -1.0 -1.0 0.2 1.2 0.5 NCO / NHL 0.76 0.66 0.37 0.40 0.47 growth NCO / loans 0.26 0.23 0.13 0.14 0.17 Total RWA BDD / NHL 0.48 0.33 0.42 0.48 0.57 BDD / loans 0.16 0.12 0.15 0.17 0.20 Valuation summary Impaireds / NHL 2.03 1.19 1.12 1.10 1.09 Preferred methodology: Problem loans / loans 1.13 0.79 0.75 0.73 0.73 Problem loans / RWA 1.98 1.38 1.31 1.28 1.28 Individ'l prov'ns / impaireds 37.9 37.1 35.9 35.9 35.9 Discounted cashflow $40.62 10.6% cost of equity Collective prov'ns / NHL 1.46 1.33 1.28 1.28 1.28 Price / earnings $32.42 13.0x - 15 year adjusted historic average Collective prov'ns / CRWA 0.99 0.93 0.90 0.90 0.90 Price / underlying earnings $31.19 7.9x - 15 year adjusted historic average Collective prov'ns / RWA 0.84 0.79 0.76 0.76 0.77 Price / net tangible assets $29.44 2.1x - imputed using Gordon's Growth Total prov'ns / NHL 2.23 1.77 1.68 1.67 1.67 Average $33.42 Unweighted average Total prov'ns / CRWA 1.52 1.24 1.18 1.17 1.18 Total prov'ns / RWA 1.28 1.05 1.00 1.00 1.00 Terminal growth rate 3.0% Value of cash flows 9.1 9.0 9.2 9.5 9.7 Risk free rate (Rf) 4.0% Value of franking credits Tier 1 ratio 10.7 10.6 10.7 10.9 11.1 Market risk premium (Rm) 6.0% Equity value Total capital ratio 12.3 12.3 12.3 12.4 12.5 Equity Beta (B) Dividend payout ratio 76.4 74.2 75.3 75.1 75.1 Ke = Rf + B * Rm Asset quality growth AU customer deposits NZ customer deposits 42,790 45,166 51,229 53,732 56,358 Other lending 10,077 13,791 17,600 17,640 18,608 36.9 27.6 0.2 5.5 24,812 32,526 41,509 41,603 43,886 539,806 583,516 631,132 664,677 700,192 8.1 8.2 5.3 5.3 331,387 359,822 379,573 401,292 growth Other customer deposits Total lending Capital Common equity Tier 1 AU lending 307,372 Blend Ouput Input Discounted cashflow inputs 1.1 10.6% 101,924 26,389 128,313 Shares on issue - EOP 3,158 Equity value per share $40.62 SOURCES: MORGANS FORECASTS, COMPANY REPORTS 19 BANKS April 23, 2015 ANZ – ADD (TARGET PRICE A$38.85) ANZ reports on Tuesday, 5 May. We forecast 1H15 cash earnings growth of 4.5% on the pcp to A$3,669m (1H14A A$3,512m), cash EPS (basic) of 134.1c (129.3c) and interim DPS of 87c (83c). Figure 43: ANZ – 1H15 result estimates (A$m) Summary profit and loss Average interest earnings assets Net interest margin Net interest income Non-interest income Total revenue Operating expenses Underlying earnings Bad debt expense Pre-tax earnings Tax expense OEIs Preference dividends Cash earnings Non-cash adjustments Reported earnings Cash earnings per share (c) - basic Dividends per share (c) 1H14A 2H14A 1H15F 1H15F / 1H14A 1H15F / 2H14A FY14A FY15F FY15F / FY14A 632,400 2.15% 6,764 2,905 9,669 -4,286 5,383 -529 4,854 -1,333 -6 -3 3,512 -120 3,392 129.3 83.0 661,515 2.12% 7,033 2,879 9,912 -4,474 5,438 -463 4,975 -1,367 -6 -3 3,599 280 3,879 132.1 95.0 695,176 2.05% 7,114 2,984 10,097 -4,538 5,560 -486 5,074 -1,395 -6 -3 3,669 3 3,672 134.1 87.0 9.9% -4.3% 5.2% 2.7% 4.4% 5.9% 3.3% -8.1% 4.5% 4.7% 0.0% 0.0% 4.5% -102.5% 8.3% 3.7% 4.8% 5.1% -3.2% 1.1% 3.6% 1.9% 1.4% 2.2% 5.0% 2.0% 2.1% 0.0% 0.0% 2.0% -98.9% -5.3% 1.5% -8.4% 646,958 2.13% 13,797 5,784 19,581 -8,760 10,821 -992 9,829 -2,700 -12 -6 7,111 160 7,271 261.5 178.0 713,528 2.04% 14,526 6,221 20,747 -9,231 11,516 -1,041 10,475 -2,881 -12 -6 7,577 6 7,583 276.2 188.0 10.3% -4.5% 5.3% 7.6% 6.0% 5.4% 6.4% 4.9% 6.6% 6.7% 0.0% 0.0% 6.5% -96.3% 4.3% 5.6% 5.6% SOURCES: MORGANS FORECASTS, COMPANY REPORTS Result day focus Earnings guidance: We will look to see whether ANZ choses to reinstate earnings guidance after dropping its FY14 earnings guidance (revenue +4-5%, expenses +2%) into FY15. For now we believe ANZ is sticking with its FY16 target of achieving ‘above peer’ EPS growth. Margin: In 1Q15 ANZ’s group net interest margin fell by 6bp on 2H14, which was much weaker than peers. Much of the weakness was attributable to one-offs relating to FX, adverse trends in Markets, and higher liquids holdings. To this end we expect only marginal weakness in 2Q15, for the 1H15 result to be down 7bps on 1H15. FX: ANZ has the largest foreign currency exposure of the big four banks, with the New Zealand and Asia Pacific Europe & America regions providing 20% and 15% of group cash NPAT, respectively. With the fall in the average value of the AUD against the USD (and Asian currencies tied to the USD) and NZD in 1H15, we will look at the extent to which realised losses on FX hedges offset translation gains. Investment view ANZ is our preferred pick of the major banks. Within the sector ANZ offers valuation appeal trading at a 13% discount to the sector, at levels consistent with the GFC when ANZ’s commercial book was in melt down. We think many of the sources of ANZ’s 1Q15 revenue weakness will be temporary, and think management’s capacity and focus on cost management should support underlying earnings growth in the near term. Further, we think ANZ’s asset quality metrics have improved more than peers since the FY09-10 peak on a number of metrics with the risk profile of the commerical book now much improved. Recent China weakness is likely weighing on sentiment for ANZ, although we remain optimistic that ANZ can increase returns in its Asian business (driven by improvements to costs, margins and more broadly, an unwind of global macroeconomic settings, which have been a headwind for the business in recent years). 20 BANKS April 23, 2015 Figure 44: ANZ – financial summary Company: ASX code ANZ Banking Group ANZ Profit & loss (A$m) Recommendation Add Average IEA FY13A FY14A FY15F FY16F FY17F 576,131 646,958 713,528 760,698 799,021 2.22 2.13 2.04 1.99 1.97 12,772 13,797 14,526 15,153 15,756 Bloomberg code ANZ AU Terminal year FY19F Margin (%) Reuters code ANZ.AX Valuation date Mar-16 Net Interest income Valuation $35.28 Lending fees 744 779 747 796 869 Price target $38.85 Non-lending fees 1,715 1,736 1,830 1,951 2,044 Upside/(downside) 10.2% Trading income 1,701 Share price $35.26 No. of shares (m) 2,766 Market cap (A$m) 97,528 Year end Sep Implied cash PE 13.0x 1,336 1,101 1,281 1,558 Wealth management income 524 539 559 616 679 Life insurance income 692 744 867 956 1,054 Other income 617 885 937 999 1,048 18,400 19,581 20,747 22,030 23,152 Forecast summary FY13A FY14A FY15F FY16F FY17F Total income Reported PTP (A$m) 8,945 9,829 10,475 11,231 11,677 Expenses -8,249 -8,760 -9,231 -9,571 -9,966 9.9 6.6 7.2 4.0 Underlying Profit 10,151 10,821 11,516 12,459 13,186 6,266 7,271 7,583 8,131 8,454 Net write-offs -1,419 -1,378 -973 -1,166 -1,302 224 257 265 281 290 Movement in provisions 213 386 -68 -61 -207 9.0 14.9 3.1 6.1 3.0 Underlying earnings 8,945 9,829 10,475 11,231 11,677 6,494 7,111 7,577 8,125 8,448 -2,435 -2,700 -2,881 -3,089 -3,211 232 252 265 281 290 Minorities -10 -12 -12 -12 -12 6.0 8.6 5.3 6.1 3.0 Preference dividends -6 -6 -6 -6 -6 375 398 420 450 473 Cash earnings 6,494 7,111 7,577 8,125 8,448 Book value per share (c) 1,628 1,753 1,933 2,028 2,142 Non-recurring items 0 NTA per share (c) 1,348 1,465 1,647 1,744 1,861 Non-cash items 164 178 188 199 206 Reported net profit 13.1 8.5 5.6 5.9 3.5 Dilutive adjustments growth Reported net profit (A$m) Reported EPS (c) growth Cash earnings (A$m) Cash EPS (c) growth Underlying EPS (c) Dividend per share (c) growth 7.2 Taxation Diluted shares on issue Valuation summary -42 -45 0 0 -186 205 6 6 6 6,266 7,271 7,583 8,131 8,454 224 243 254 254 254 2,897 2,919 2,953 2,979 3,004 290 FY13A FY14A FY15F FY16F FY17F Cash eps (c) 232 252 265 281 15.2x 14.0x 13.3x 12.5x 12.2x Cash eps growth (%) 6.0 8.6 5.3 6.1 3.0 Price / underlying earnings 9.4x 8.9x 8.4x 7.8x 7.5x Cash eps (c) - basic 240 261 276 294 303 Price / net tangible assets 2.6x 2.4x 2.1x 2.0x 1.9x Dividends per share (c) 164 178 188 199 206 4.7 5.0 5.3 5.6 5.8 18.8 18.7 17.7 17.4 16.9 Price / earnings Dividend yield (%) ROTE (%) Ratio analysis (%) FY13A FY14A FY15F FY16F FY17F Profitability Balance sheet (A$m) FY13A FY14A FY15F FY16F FY17F AU housing lending 194,755 209,122 225,840 237,462 249,067 AU business lending 115,660 126,041 134,750 144,433 156,310 AU personal lending 17,210 16,715 16,209 16,404 16,701 327,625 351,878 376,798 398,299 422,079 7.4 7.1 5.7 6.0 240,169 256,950 275,149 290,836 308,178 89,867 94,574 109,638 114,996 120,616 5.2 15.9 4.9 4.9 ROE (reported) 14.8 15.8 14.9 14.9 14.6 ROE (cash) 15.4 15.5 14.9 14.9 14.6 ROTE (cash) 18.8 18.7 17.7 17.4 16.9 RORWA (cash) 2.0 2.0 2.0 2.0 1.9 NZ lending ROA (cash) 1.0 0.9 0.9 0.9 0.9 growth ROTA (cash) 1.0 1.0 0.9 0.9 0.9 Non-int. income / income 30.6 29.5 30.0 31.2 31.9 Cost-to-income ratio 44.8 44.7 44.5 43.4 43.0 2.7 0.2 0.6 2.5 1.0 NCO / NHL 0.64 0.55 0.35 0.40 0.42 growth NCO / loans 0.31 0.27 0.17 0.19 0.20 Total RWA BDD / NHL 0.54 0.40 0.38 0.42 0.49 BDD / loans 0.26 0.19 0.18 0.20 0.24 Valuation summary Impaireds / NHL 1.75 1.08 0.90 0.86 0.86 Preferred methodology: Problem loans / loans 1.21 0.90 0.76 0.72 0.72 Problem loans / RWA 1.74 1.31 1.10 1.04 1.05 Individ'l prov'ns / impaireds 35.9 42.8 42.3 41.3 40.3 Discounted cashflow $43.62 10.6% cost of equity Collective prov'ns / NHL 1.23 1.08 1.02 1.01 1.00 Price / earnings $34.29 11.7x - 15 year adjusted historic average Collective prov'ns / CRWA 1.00 0.89 0.85 0.84 0.83 Price / underlying earnings $31.38 6.9x - 15 year adjusted historic average Collective prov'ns / RWA 0.85 0.76 0.72 0.71 0.71 Price / net tangible assets $31.84 1.8x - imputed using Gordon's Growth Total prov'ns / NHL 1.86 1.55 1.41 1.37 1.35 Average $35.28 Unweighted average Total prov'ns / CRWA 1.51 1.27 1.16 1.13 1.12 Total prov'ns / RWA 1.28 1.09 0.99 0.96 0.95 Terminal growth rate 3.0% Value of cash flows 8.5 8.8 9.1 9.3 9.5 Risk free rate (Rf) 4.0% Value of franking credits Tier 1 ratio 10.4 10.7 10.8 10.9 11.0 Market risk premium (Rm) 6.0% Equity value Total capital ratio 12.2 12.7 12.5 12.6 12.6 Equity Beta (B) Dividend payout ratio 68.4 68.1 68.1 67.8 68.0 Ke = Rf + B * Rm Revenue less cost growth Asset quality Capital Common equity Tier 1 AU lending growth AU customer deposits NZ customer deposits 72,547 76,759 88,986 93,334 97,896 Other lending 70,137 79,082 96,823 97,024 102,326 12.8 22.4 0.2 5.5 growth Other customer deposits 113,357 121,625 148,910 149,219 157,373 Total lending 487,629 525,534 583,259 610,319 645,021 7.8 11.0 4.6 5.7 361,529 403,122 421,116 447,127 339,265 Blend Ouput Input Discounted cashflow inputs 1.1 10.6% 98,077 23,768 121,845 Shares on issue - EOP 2,793 Equity value per share $43.62 SOURCES: MORGANS FORECASTS, COMPANY REPORTS 21 BANKS April 23, 2015 NAB – HOLD (TARGET PRICE A$40.90) NAB reports on Thursday, 7 May. We forecast 1H15 cash earnings growth of 6.7%% on the pcp to A$3,360m (1H14A A$3,150m), cash EPS (basic) of 140.6c (134.1c) and final DPS of 104c (99c). Figure 45: NAB – 1H15 result estimates (A$m) Summary profit and loss Average interest earnings assets Net interest margin Net interest income Non-interest income Total revenue Operating expenses Underlying earnings Bad debt expense Pre-tax earnings Tax expense OEIs Preference dividends Cash earnings Non-cash adjustments Reported earnings Cash earnings per share (c) - basic Dividends per share (c) 1H14A 2H14A 1H15F 1H15F / 1H14A 1H15F / 2H14A FY14A FY15F FY15F / FY14A 707,170 1.94% 6,843 2,644 9,487 -4,456 5,031 -528 4,503 -1,263 0 -90 3,150 -294 2,856 134.1 99.0 715,993 1.93% 6,932 2,494 9,426 -5,724 3,702 -349 3,353 -1,229 0 -90 2,034 405 2,439 86.2 99.0 742,444 1.91% 7,081 2,697 9,778 -4,563 5,215 -422 4,792 -1,342 0 -90 3,360 90 3,450 140.6 104.0 5.0% -1.4% 3.5% 2.0% 3.1% 2.4% 3.6% -20.0% 6.4% 6.2% n.a. 0.0% 6.7% -130.6% 20.8% 4.9% 5.1% 3.7% -1.0% 2.1% 8.1% 3.7% -20.3% 40.9% 21.0% 42.9% 9.2% n.a. 0.0% 65.2% -77.8% 41.5% 63.1% 5.1% 711,582 1.94% 13,775 5,138 18,913 -10,180 8,733 -877 7,856 -2,492 0 -180 5,184 111 5,295 220.2 198.0 758,137 1.90% 14,422 5,577 19,999 -9,296 10,704 -955 9,749 -2,730 0 -180 6,839 180 7,019 284.3 210.0 6.5% -1.7% 4.7% 8.5% 5.7% -8.7% 22.6% 8.9% 24.1% 9.5% n.a. 0.0% 31.9% 62.2% 32.6% 29.1% 6.1% SOURCES: MORGANS FORECASTS, COMPANY REPORTS Result day focus UK redress: Since its 1Q15 update, Clydesdale has been fined by the FCA for inadequacies in its PPI redress handling, and the UK Treasury Committee suggested NAB needs to overhaul its interest rate swap miss-selling redress program. While we think existing PPI provisions should remain adequate, we see strong potential for a top up of interest rate swap miss-selling provisions, and have catered for A$400m additional provisions in our FY15 estimates. UK Banking: More broadly, the UK economic recovery remains intact, and we expect this should continue to support credit quality improvements, a higher net interest margin and some progress on lowering UK Banking’s cost-to-income ratio. After NAB’s commitment to selling Clydesdale, we would expect some colour on progress to date, and would note the recent bid for TSB at a slight premium to book value bodes well for a potential IPO. Asset quality: NAB’s 1Q15 bad debt charge of A$227m increased on the 4Q14 outcome (A$108m) although the 4Q14 result included the release of economic cycle overlay (+A50m), write-backs in UK CRE (+A54m), and a strong fall in the UK bad debt charge. To this end, the 2H14 result looks to be the bottom for NAB, particularly as the shift to expected loss accounting rules will limit the scope for further provision releases. Investment view Since new management has begun to deliver on its commitment to boost returns for the group (largely through shedding non-core businesses), NAB has re-rated back toward its long run average 7% discount to the sector, after trading at a much steeper discount through much of 2014. After dealing with low hanging fruit, to drive further rerating we think management needs to demonstrate sustainable improvements in its core business banking franchise, and or achieve a decent outcome on fully exiting the UK. In the near term we remain concerned that further provisions for interest rate swap miss-selling may weigh on performance. We have a Hold rating on NAB and it is our #3 pick of the major banks. 22 BANKS April 23, 2015 Figure 46: NAB – financial summary Company: ASX code National Australia Bank NAB Profit & loss (A$m) Recommendation Hold Average IEA FY13A FY14A FY15F FY16F FY17F 661,523 711,582 758,137 806,640 847,265 2.03 1.94 1.90 1.87 1.86 13,407 13,775 14,422 15,045 15,746 Bloomberg code NAB AU Terminal year FY19F Margin (%) Reuters code NAB.AX Valuation date Mar-16 Net Interest income Valuation $37.15 Lending fees 969 943 972 1,036 1,094 Price target $40.90 Non-lending fees 1,526 1,562 1,624 1,726 1,807 Share price $37.84 No. of shares (m) 2,421 Market cap (A$m) 91,615 Year end Sep Upside/(downside) 8.1% Trading income 1,094 892 1,156 1,283 1,382 Implied cash PE 13.2x Wealth management income 1,050 1,082 1,141 1,259 1,389 Life insurance income 338 358 449 588 751 Other income 179 301 235 250 262 18,563 18,913 19,999 21,186 22,430 Forecast summary FY13A FY14A FY15F FY16F FY17F Total income Reported PTP (A$m) 8,423 7,856 9,749 10,502 11,056 Expenses -8,206 -10,180 -9,296 -9,264 -9,651 7.5 -6.7 24.1 7.7 5.3 Underlying Profit 10,357 8,733 10,704 11,922 12,779 5,355 5,295 7,019 7,562 7,960 Net write-offs -2,138 -1,575 -1,084 -1,336 -1,597 219 214 278 295 307 Movement in provisions 204 698 128 -83 -126 27.3 -2.5 29.8 6.2 4.2 Underlying earnings 8,423 7,856 9,749 10,502 11,056 5,910 5,184 6,839 7,382 7,780 -2,325 -2,492 -2,730 -2,941 -3,096 251 217 278 295 307 Minorities 0 0 0 0 0 4.3 -13.6 28.1 6.2 4.2 Preference dividends -188 -180 -180 -180 -180 Cash earnings 7,780 growth Reported net profit (A$m) Reported EPS (c) growth Cash earnings (A$m) Cash EPS (c) growth Underlying EPS (c) Taxation 444 371 445 488 518 5,910 5,184 6,839 7,382 Book value per share (c) 1,779 1,841 2,008 2,102 2,206 Non-recurring items -201 -89 0 0 0 NTA per share (c) 1,454 1,515 1,690 1,787 1,895 Non-cash items -354 200 180 180 180 190 198 210 226 236 Reported net profit 5,355 5,295 7,019 7,562 7,960 5.6 4.2 6.1 7.6 4.4 Dilutive adjustments 42 124 140 140 140 2,374 2,450 2,515 2,552 2,579 307 Dividend per share (c) growth Diluted shares on issue Valuation summary FY13A FY14A FY15F FY16F FY17F Cash eps (c) 251 217 278 295 15.1x 17.5x 13.6x 12.8x 12.3x Cash eps growth (%) 4.3 -13.6 28.1 6.2 4.2 Price / underlying earnings 8.5x 10.2x 8.5x 7.7x 7.3x Cash eps (c) - basic 253 220 284 302 315 Price / net tangible assets 2.6x 2.5x 2.2x 2.1x 2.0x Dividends per share (c) 190 198 210 226 236 5.0 5.2 5.5 6.0 6.2 18.3 14.9 17.6 17.4 17.2 Price / earnings Dividend yield (%) ROTE (%) Ratio analysis (%) FY13A FY14A FY15F FY16F FY17F Profitability Balance sheet (A$m) FY13A FY14A FY15F FY16F FY17F AU housing lending 232,251 247,312 265,543 280,299 294,572 AU business lending 151,264 151,831 162,321 173,986 186,488 AU personal lending 9,051 9,132 9,072 9,036 9,200 392,566 408,275 436,937 463,321 490,260 4.0 7.0 6.0 5.8 289,085 313,500 335,530 355,556 375,929 70,558 76,586 88,470 92,794 97,328 8.5 15.5 4.9 4.9 ROE (reported) 13.5 12.5 15.1 15.1 15.0 ROE (cash) 14.9 12.2 14.7 14.7 14.7 ROTE (cash) 18.3 14.9 17.6 17.4 17.2 RORWA (cash) 1.7 1.4 1.8 1.8 1.8 NZ lending ROA (cash) 0.7 0.6 0.7 0.8 0.8 growth ROTA (cash) 0.7 0.6 0.7 0.8 0.8 Non-int. income / income 27.8 27.2 27.9 29.0 29.8 Cost-to-income ratio 44.2 53.8 46.5 43.7 43.0 Revenue less cost growth -3.3 -22.2 14.4 6.3 1.7 NCO / NHL 0.94 0.68 0.45 0.52 0.58 growth NCO / loans 0.42 0.30 0.19 0.22 0.25 Total RWA BDD / NHL 0.85 0.38 0.39 0.55 0.63 BDD / loans 0.38 0.16 0.17 0.23 0.27 Valuation summary Impaireds / NHL 2.73 1.77 1.35 1.17 1.01 Preferred methodology: Problem loans / loans 1.69 1.19 0.90 0.78 0.68 Problem loans / RWA 2.43 1.76 1.35 1.17 1.01 Individ'l prov'ns / impaireds 32.0 35.3 35.3 35.3 35.3 Discounted cashflow $45.70 10.6% cost of equity Collective prov'ns / NHL 1.27 1.13 1.38 1.38 1.38 Price / earnings $35.52 11.8x - 15 year adjusted historic average Collective prov'ns / CRWA 0.94 0.83 1.01 1.01 1.02 Price / underlying earnings $34.22 7.0x - 15 year adjusted historic average Collective prov'ns / RWA 0.82 0.72 0.88 0.88 0.88 Price / net tangible assets $33.15 1.8x - imputed using Gordon's Growth Total prov'ns / NHL 2.14 1.75 1.85 1.79 1.73 Average $37.15 Unweighted average Total prov'ns / CRWA 1.59 1.28 1.36 1.32 1.28 Total prov'ns / RWA 1.38 1.11 1.18 1.14 1.11 Terminal growth rate 3.0% Value of cash flows 8.4 8.6 9.1 9.2 9.4 Risk free rate (Rf) 4.0% Value of franking credits Tier 1 ratio 10.4 10.8 11.1 11.2 11.2 Market risk premium (Rm) 6.0% Equity value Total capital ratio 11.8 12.2 12.4 12.4 12.4 Equity Beta (B) Dividend payout ratio 75.1 89.9 73.9 74.7 74.8 Ke = Rf + B * Rm Asset quality growth AU customer deposits NZ customer deposits 67,647 74,708 86,301 90,518 94,942 Other lending 58,955 60,510 67,290 66,226 67,294 n.a. n.a. n.a. n.a. 71,712 70,439 78,332 77,093 78,336 522,079 545,371 592,698 622,341 654,882 4.5 8.7 5.0 5.2 367,652 397,605 418,357 441,720 growth Other customer deposits Total lending Capital Common equity Tier 1 AU lending 362,078 Blend Ouput Input Discounted cashflow inputs 1.1 10.6% 87,816 23,765 111,581 Shares on issue - EOP 2,441 Equity value per share $45.70 SOURCES: MORGANS FORECASTS, COMPANY REPORTS 23 BANKS April 23, 2015 Figure 47: CBA – financial summary Company: ASX code Commonwealth Bank of Australia CBA Profit & loss (A$m) Recommendation Hold Average IEA FY13A FY14A FY15F FY16F FY17F 653,673 705,498 752,184 801,507 843,551 2.13 2.14 2.10 2.05 2.01 13,944 15,091 15,816 16,438 16,925 Bloomberg code CBA AU Terminal year FY19F Margin (%) Reuters code CBA.AX Valuation date Dec-15 Net Interest income Valuation $76.11 Lending fees 1,053 1,083 1,056 1,094 1,145 Price target $85.86 Non-lending fees 1,990 2,130 2,280 2,410 2,511 Upside/(downside) -5.4% Trading income 863 922 1,036 1,141 1,243 Implied cash PE 14.3x Wealth management income 1,828 1,933 1,980 2,193 2,420 Life insurance income 893 1,054 996 1,086 1,197 Other income 250 188 408 312 329 20,821 22,401 23,571 24,674 25,769 Share price No. of shares (m) Market cap (A$m) Year end $90.72 1,627,593 147,655 Jun Forecast summary FY13A FY14A FY15F FY16F FY17F Total income Reported PTP (A$m) 10,729 Expenses -9,010 -9,499 -9,778 -10,117 -10,567 Underlying Profit 11,811 12,902 13,794 14,556 15,201 Net write-offs -1,735 -1,648 -893 -946 -1,085 653 695 -49 -215 -226 11,949 12,852 13,395 13,891 8.8 11.4 7.6 4.2 3.7 7,618 8,631 9,235 9,718 10,078 459 520 552 576 591 Movement in provisions 6.4 13.2 6.2 4.2 2.7 Underlying earnings 10,729 11,949 12,852 13,395 13,891 7,720 8,635 9,275 9,670 10,030 Taxation -2,953 -3,250 -3,509 -3,657 -3,793 468 523 558 576 591 Minorities -16 -19 -20 -20 -20 8.0 11.8 6.6 3.2 2.7 Preference dividends -40 -45 -48 -48 -48 738 801 851 890 921 Cash earnings 7,720 8,635 9,275 9,670 10,030 Book value per share (c) 2,733 2,953 3,181 3,390 3,602 Non-recurring items -124 -97 -46 0 0 NTA per share (c) 2,087 2,349 2,575 2,789 3,007 Non-cash items 22 93 6 48 48 364 401 428 442 457 Reported net profit 7,618 8,631 9,235 9,718 10,078 9.0 10.2 6.7 3.3 3.4 Dilutive adjustments 193 190 226 226 226 1,692 1,688 1,704 1,719 1,736 591 growth Reported net profit (A$m) Reported EPS (c) growth Cash earnings (A$m) Cash EPS (c) growth Underlying EPS (c) Dividend per share (c) growth Diluted shares on issue Valuation summary FY13A FY14A FY15F FY16F FY17F Cash eps (c) 468 523 558 576 Price / earnings 19.4x 17.3x 16.3x 15.8x 15.4x Cash eps growth (%) 8.0 11.8 6.6 3.2 2.7 Price / underlying earnings 12.3x 11.3x 10.7x 10.2x 9.9x Cash eps (c) - basic 482 536 572 591 607 Price / net tangible assets 4.3x 3.9x 3.5x 3.3x 3.0x Dividends per share (c) 364 401 428 442 457 4.0 4.4 4.7 4.9 5.0 24.0 23.6 23.0 21.7 20.7 Dividend yield (%) ROTE (%) Ratio analysis (%) FY13A FY14A FY15F FY16F FY17F Profitability Balance sheet (A$m) FY13A FY14A FY15F FY16F FY17F AU housing lending 338,023 360,218 383,107 403,619 423,344 AU business lending 146,426 151,654 159,833 171,318 183,629 AU personal lending 18,897 19,593 19,711 19,948 20,269 503,346 531,465 562,650 594,885 627,242 5.6 5.9 5.7 5.4 404,213 431,844 464,062 490,623 517,277 52,034 59,523 66,238 69,475 72,871 14.4 11.3 4.9 4.9 ROE (reported) 17.9 18.6 18.4 17.9 17.3 ROE (cash) 18.2 18.6 18.5 17.8 17.2 ROTE (cash) 24.0 23.6 23.0 21.7 20.7 RORWA (cash) 2.4 2.6 2.6 2.6 2.5 NZ lending ROA (cash) 1.1 1.1 1.1 1.1 1.1 growth ROTA (cash) 1.1 1.1 1.1 1.1 1.1 Non-int. income / income 33.0 32.6 32.9 33.4 34.3 Cost-to-income ratio 43.3 42.4 41.5 41.0 41.0 5.4 2.2 2.3 1.2 0.0 NCO / NHL 0.90 0.81 0.41 0.41 0.44 growth NCO / loans 0.31 0.28 0.14 0.14 0.15 Total RWA BDD / NHL 0.56 0.47 0.43 0.50 0.54 BDD / loans 0.19 0.16 0.15 0.17 0.19 Valuation summary Impaireds / NHL 2.21 1.62 1.54 1.51 1.48 Preferred methodology: Problem loans / loans 1.15 0.94 0.87 0.85 0.84 Problem loans / RWA 1.99 1.69 1.54 1.52 1.50 Individ'l prov'ns / impaireds 37.6 33.5 33.2 33.2 33.2 Discounted cashflow $91.86 10.6% cost of equity Collective prov'ns / NHL 1.46 1.33 1.28 1.28 1.28 Price / earnings $77.33 13.9x - 15 year adjusted historic average Collective prov'ns / CRWA 1.02 0.96 1.31 1.31 1.31 Price / underlying earnings $72.44 8.6x - 15 year adjusted historic average Collective prov'ns / RWA 0.87 0.82 0.78 0.78 0.79 Price / net tangible assets $62.83 2.2x - imputed using Gordon's Growth Total prov'ns / NHL 2.29 1.87 1.79 1.78 1.77 Average $76.11 Unweighted average Total prov'ns / CRWA 1.60 1.35 1.83 1.82 1.82 Total prov'ns / RWA 1.36 1.16 1.09 1.09 1.09 Terminal growth rate 3.0% Value of cash flows 8.2 9.3 9.5 10.0 10.1 Risk free rate (Rf) 4.0% Value of franking credits Tier 1 ratio 10.3 11.1 11.8 12.2 12.2 Market risk premium (Rm) 6.0% Equity value Total capital ratio 11.2 12.0 12.8 13.2 13.2 Equity Beta (B) Dividend payout ratio 75.5 74.8 74.8 74.8 75.2 Ke = Rf + B * Rm Revenue less cost growth Asset quality growth AU customer deposits NZ customer deposits 34,396 40,884 47,214 49,521 51,942 Other lending 13,441 17,139 21,338 21,835 22,093 27.5 24.5 2.3 1.2 15,248 15,663 17,472 17,878 18,090 568,821 608,127 650,226 686,195 722,207 6.9 6.9 5.5 5.2 337,715 365,612 386,252 407,222 growth Other customer deposits Total lending Capital Core equity tier 1 ratio AU lending 329,158 Blend Ouput Input Discounted cashflow inputs 1.1 10.6% 119,700 30,708 150,408 Shares on issue - EOP 1,637 Equity value per share $91.86 SOURCES: MORGANS FORECASTS, COMPANY REPORTS 24 BANKS April 23, 2015 QUEENSLAND BRISBANE - HEAD OFFICE BRISBANE - EDWARD STREET BRISBANE - TYNAN PARTNERS BUNDABERG CAIRNS CALOUNDRA EMERALD GLADSTONE GOLD COAST IPSWICH/SPRINGFIELD KEDRON MACKAY MILTON MT GRAVATT/CAPALABA NOOSA REDCLIFFE ROCKHAMPTON SPRING HILL SUNSHINE COAST TOOWOOMBA TOWNSVILLE YEPPOON (07) 3334 4888 (07) 3121 5677 (07) 3152 0600 (07) 4153 1050 (07) 4222 0555 (07) 5491 5422 (07) 4988 2777 (07) 4972 8000 (07) 5581 5777 (07) 3202 3995 (07) 3350 9000 (07) 4957 3033 (07) 3114 8600 (07) 3245 5466 (07) 5449 9511 (07) 3897 3999 (07) 4922 5855 (07) 3833 9333 (07) 5479 2757 (07) 4639 1277 (07) 4725 5787 (07) 4939 3021 NEW SOUTH WALES SYDNEY ARMIDALE BALLINA BALMAIN BOWRAL CHATSWOOD COFFS HARBOUR GOSFORD HURSTVILLE MERIMBULA NEUTRAL BAY NEWCASTLE NEWPORT (02) 8215 5055 (02) 6770 3300 (02) 6686 4144 (02) 8755 3333 (02) 4851 5515 (02) 8116 1700 (02) 6651 5700 (02) 4325 0884 (02) 9570 5755 (02) 6495 2869 (02) 8969 7500 (02) 4926 4044 (02) 9998 4200 PORT MACQUARIE SCONE SYDNEY – LEVEL 7 CURRENCY HOUSE SYDNEY – LEVEL 9 SYDNEY – HUNTER STREET SYDNEY – REYNOLDS EQUITIES WOLLONGONG (02) 6583 1735 (02) 6544 3144 (02) 8216 5111 (02) 8215 5000 (02) 9125 1788 (02) 9615 4500 (02) 9373 4452 (02) 4227 3022 ACT CANBERRA (02) 6232 4999 VICTORIA MELBOURNE BRIGHTON CAMBERWELL CARLTON FARRER HOUSE GEELONG RICHMOND SOUTH YARRA SOUTHBANK TRARALGON WARRNAMBOOL (03) 9947 4111 (03) 9519 3555 (03) 9813 2945 (03) 9066 3200 (03) 8644 5488 (03) 5222 5128 (03) 9916 4000 (03) 8762 1400 (03) 9037 9444 (03) 5176 6055 (03) 5559 1500 WESTERN AUSTRALIA PERTH WEST PERTH (08) 6462 1999 (08) 6160 8700 SOUTH AUSTRALIA ADELAIDE NORWOOD (08) 8464 5000 (08) 8461 2800 NORTHERN TERRITORY DARWIN (08) 8981 9555 TASMANIA HOBART (03) 6236 9000 DISCLAIMER The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual’s relevant personal circumstances. 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Morgans Corporate Limited was a participating broker to the public offer of subordinated debt securities by NAB in March 2015 and received fees in this regard. Morgans Corporate Limited is a joint lead manager to the public offer of capital note securities by ANZ and may receive fees in this regard. RECOMMENDATION STRUCTURE For a full explanation of the recommendation structure, refer to our website at https://www.morgans.com.au/research_disclaimer. If you no longer wish to receive Morgans’ publications please advise your local Morgans office or write to Morgans, Reply Paid 202, Brisbane QLD 4001 and include your account details. 17.11.14 25