December 2017 reporting wrap: Fundamentals sound. The recent reporting period was generally positive with few surprises. NIM benefited from lower funding costs, deposit mix, easing liquidity drag and stable lending spreads, and the domestic retail and business banks contributed to the bulk of NIM/NIE improvements. However, non-interest income was impacted by ongoing shift towards lower fee products, lower interchange and ATM fees and lower trading activity – although these were offset by some positive CVA and better wealth outcomes from strong markets performance and positive net flows.
Underlying cost discipline remained the key value lever and resulted in positive Jaws”. The relative CIR ranges (42-46% for majors, 53-54% for regionals with BOQ being the outlier at 47% and 63-65% for smaller regionals) highlight the operating scale differences between the large and small players. Credit quality was manageable and the average sector BDD charge continued to gradually normalise towards the new normal range (majors 20-30bp, regionals 10-20bp and smaller regionals up to 10bp). Consumer BDD charges remained in good shape across all categories (e.g. expected mortgage loss only 2bp) and are in line with lower arrears and impaired asset experience. Capital adequacy and funding were non-issues in the reporting period.
The respective outlook statements continue to emphasise cautious optimism in a challenging environment (NIM and non-interest income headwinds). We thus expect cost discipline to be ongoing and to underpin underlying earnings growth and CET1 capital generation, and for dividend payout intentions to be unchanged.
Domestic retail and business banks still core to the majors
There is no denying these are the majors’ most valuable businesses, e.g. CBA’s RBS and B&PB combined NIM in 1H18 was a very healthy 2.95% while CIR was in the low 30s. Based on 1.5% and 1.6% ROA respectively and assuming the Group’s conservative equity ratio, the respective ROE would be ~21% and ~24% (~22% combined). Based on a 10.5% CET1 requirement and given RBS’s lower risk weights, ROE would be very attractive at ~36% and ~20% respectively (~30% combined).
Forecast/price target/rating changes and top picks
Forecast changes: BOQ cash NPAT -3% after lowering NIM by 3bp.
Price target changes: ABA from $5.80 to $5.65 due to softer NIM outlook; BEN from $11.90 to $11.65 due to rebased dividend valuation; BOQ from $13.50 to $12.85 due to softer NIM outlook; MQG from $109.50 to $111.00 due to valuation time creep; and WBC from $33.90 to $33.00 due to rebased ROE and dividend valuation.
Rating changes: SUN from Buy to Hold purely based on value (i.e. TSR now <8%).
Top picks: (1) MQG (track record; risk management; growth outlook based on global asset management, infrastructure and overseas footprints; high ROE annuity-style components; and capital management flexibility); and (2) NAB (niche business bank; execution; risk management; cost discipline; capital position; and focus on ROE).