The modest slowing of credit growth in Australia is more than offset by improving economic circumstances as global and domestic economic conditions continued to recover.
Australian research firm Morningstar issued ratings on each of Australia’s four big banks — National Australia Bank, Commonwealth Bank of Australia, ANZ and Westpac. Each of those banks owns respectively in New Zealand the BNZ, ASB, ANZ and Westpac.
Morningstar made no changes to its fair value estimates for the banks, each regarded as having a wide competitive advantage.CBA and Westpac were undervalued, trading 12% and 9% below fair value estimates. NBA and ANZ were trading close to valuations.
"We continue to expect modest major bank earnings growth underpinned by better-than-expected economic data.
"Major bank forward price earnings ratios have contracted to an average about 13 times from 14 times five months ago and are now broadly in line with longer averages."
Morningstar was comfortable with its earnings forecasts but could not see a near-term catalyst to push bank share prices materially higher.CBA was trading at the steepest discount to fair value.
Westpac remained the preferred bank due to stronger-than-expected earnings growth, best-in-peer group efficiency, impressive returns on equity, stable senior management, strong risk management track record and an exemplary stewardship rating.
The Reserve Bank of Australia was increasingly confident GDP growth would accelerate from just above 2% this year to about 3% next year, Morningstar said.
Inflation was expected to gradually increase to the middle of the central bank’s 2% to 3% target band and unemployment was likely to improve from current levels of about 5.6%.
Employment had increased in all Australian states, accompanied by a rise in the participation rate, and record high job vacancies data for August suggest the unemployment rate could fall to low 5% levels by mid-2018.
"Although wage growth and savings levels remain low, on balance we believe the current macroeconomic backdrop remains favourable for the four major banks."
The RBA left interest rates at 1.5% on October 3, noting there had been more consistent signs non-mining business investment was improving.
Morningstar had long argued recession fears in Australia were overdone as exports, consumption, residential construction and public-sector infrastructure spending was underpinning economic activity, despite soft wages growth.
Importantly, meaningful population growth continued to support solid economic activity and strong demand for housing.
"The Australian economy has proven itself to be more resilient and flexible than many anticipated. The surprisingly strong recovery in commodity prices during the past 18 months has partially offset the investment boom aftershock that hit the resource-dependent state of Western Australia, and regions in North Queensland and South Australia."
The household sector had coped well with higher debt levels, although high household debt was a key risk to financial stability in the case of an exogenous shock to the economy.
The four major banks were considered too big to fail, but it really was the highly leveraged Australian household sector that was too big to fail, accounting for 55% to 60% of domestic consumption, Morningstar said.
"For this reason, we anticipate the RBA will tread very carefully when it eventually starts to normalise interest rates. We expect the RBA cash rate to remain at 1.5% throughout 2018."
The big four
WESTPAC
Westpac is Australia’s oldest bank, marking 200 years in 2017. Some commentators view Westpac’s successful home loan growth strategy as a key weakness but Morningstar says it is a core strength. Investor concerns, centred on the large exposure to residential mortgages, are overdone. The high-profile multibrand franchise in Australia and New Zealand is slanted towards retail banking but retains meaningful exposure to wealth, corporate and institutional sectors. Morningstar forecasts solid earnings upside potential as international investors continue to focus too much attention on negative short-term issues.
NATIONAL AUSTRALIA BANK
National Australia Bank is Australia’s biggest business bank. Chief executive Andrew Thorburn and senior management have started the business optimisation process and are expected to provide consistent, high-quality earnings, erasing previous disappointments and rebuilding investor confidence. Good revenue and volume growth, tight cost control and improved return on equity will feature.
COMMONWEALTH BANK OF AUSTRALIA
CBA is a high-quality bank trading on an attractive fully tax-paid dividend yield. Morningstar’s view is based on the bank’s robust balance sheet, dominant market positions, strong profitability, organic capital generation capability, sound loan book and high returns on equity. A bank funding crisis, a severe downturn in Australia or a housing collapse could force share falls in earnings and dividends.
ANZ
The bank’s push into Asia and the well-regarded Australia and New Zealand franchise was slanted towards corporate and business banking and an increasing exposure to retail banking and wealth. ANZ has failed to deliver higher returns than major bank peers as a result of the lower return Asian businesses. The Asian growth strategy is based on higher growth rates than Australia and New Zealand, where household and business credit growth is modest.
