Australian banks: good profit results, solid outlook

The big four banks represent a significant proportion of the Australian share market and are a major source of dividends for investors. Three of the big four are among the top 20 holdings in Djerriwarrh’s portfolio. Portfolio Manager Brett McNeill looks at the recent ‘bank reporting season’ and considers their quality and current valuations.

ANZ, NAB, and Westpac all reported full year financial results for the period to 30 September 2022. Commonwealth Bank reported its results for the full year to 30 June 2022, but we include it here for comparison. In summary these four banks delivered good profit results matched by a solid outlook in 2022.

Commonwealth Bank is Australia’s largest bank, with both it and Westpac having the highest percentage of their loan book in Australian home loans. ANZ is more weighted towards institutional loans and NAB towards small business loans.

Results overview

Net Interest Income (NII) is the key contributor to bank profits and is even more important now that the banks have largely exited their wealth businesses. NAB delivered the best NII growth at 7.6% while Westpac was the only major bank whose NII fell, albeit mostly in the first half.

The two key drivers of NII growth are Loan Growth (volume) and Net Interest Margin (price). All the major banks generated positive Loan Growth, with NAB the sector leader.

All the majors saw their NIM (Net Interest Margin) fall for the year, with the mortgage-weighted banks – Commonwealth Bank and Westpac – faring worst. In contrast, ANZ and NAB saw relatively modest falls.

All four banks delivered growth in Operating Profit (pre bad debts, tax and other items), with NAB the standout at just over 11%.

NAB and Commonwealth Bank continue to lead the market in cost efficiency, with Cost to Income ratios around 45% while Westpac’s cost base continues to be impacted by ‘notable’ items, with management having a stated target to significantly reduce costs.

There was a surprising divergence in reported bad debt impairment charges, with Westpac and NAB reporting charges but ANZ booking a provision release. Overall, each bank reported a continued improvement in the quality of their loan book, evidenced by a reduction in problem loans.

The banks appear well provisioned when measured by Collective Provisions as a percentage of Credit Risk Weighted Assets. For example, NAB is best provisioned on this metric at 1.31%. This metric for NAB was 0.51% in 2007 heading into the GFC. Capital positions also remain strong, with Common Equity Tier One ratios between 11.0% and 11.5%. In this context, all the banks are heading into what is potentially a more uncertain economic environment in a strong position.

On the key profitability measure of Return on Equity (ROE), all the banks except Westpac delivered a solid result.

Outlook

Some of the key takeaways from the outlook comments were:

• NIMs are expected to increase, which should flow through to solid NII growth
• Loan growth will continue, but at more modest levels than in FY22
• Mortgage competition remains high
• Cost growth will continue for all the majors except for Westpac which has a major cost reduction program
• Credit quality remains very strong, albeit the banks acknowledge that the impact of higher interest rates on consumers will take time to flow through

Quality and valuation

We continue to rate Commonwealth Bank as the highest quality bank. This is predominantly based on its strong retail franchise which has delivered superior historical returns compared to its peers. This is evidenced by its sector-leading long-term Return on Equity.

Another way to consider value is the divided yields of the respective banks (the dividend yields in the below table are based on medium-term forecasts looking ahead to FY24 that attempt to normalise for some of the key items such as impairments, NIMs, and costs).

On this basis these yields are:

This shows that Westpac and ANZ offer a significantly higher dividend yield than Commonwealth Bank and NAB and the higher potential rewards from investing in ANZ and Westpac are matched by the higher risks associated with both. This includes continuing to execute a significant turnaround in the case of Westpac, and successfully integrating the Suncorp Group acquisition in the case of ANZ.

Banks in Djerriwarrh’s portfolio

The major banks play an important role in the portfolio. Whilst we are not expecting significant capital growth, they are an important source of fully franked income. In particular, when we overlay options strategies to enhance what already are attractive dividend yields, then we do not need much capital growth to justify their position in Djerriwarrh’s diversified portfolio.