We expect underlying momentum for the major banks to be steady heading into 2018 and the Royal Commission. This would reflect steady margins (repricing and lower funding cost benefits in the previous period to offset competition), volume growth in line with GDP expectations, easing prudential headwinds (e.g. capital and liquidity), stable asset quality and ongoing cost discipline to absorb the cost of the Inquiry, estimated at up to $150m for each major bank. The distraction would certainly be much greater for those with larger retail banking operations – although we feel CBA has been through a lot more soul searching in the past year and could spend incrementally less than the above figure.
We also expect the Inquiry to be less pronounced for those with larger wholesale banking (e.g. NAB and ANZ) or offshore/more diversified operations (e.g. MQG). The regional banks may emerge relatively unscathed but they remain susceptible to price wars that could be instigated by the larger banks as a response to the Commission. Adverse weather volatility aside, the general insurers should be in the sweet spot in 2018 – thanks to premium rate rises, efficiency gains, sufficient prudential buffers including strength of reinsurance arrangements and fewer political risks.
Macquarie Group (MQG)
MQG’s value lies in its ability to manage risk and adapt its strategy to remain ahead of the curve. This has enabled MQG to continually transform and push for higher/more sustainable revenues. These attributes in addition to lower-risk annuity-style earnings streams (~79% of Group net profit contribution before unallocated corporate costs, profit share and income tax), offshore exposure (~62% of operating income with ~24% from North America) and strong capital management flexibility (~$2.5bn surplus capital based on 10.5% RWA) continue to underpin our Buy rating. The strong likelihood of a lower US corporate tax rate would provide further valuation upside. Price target $108.00, Buy
National Australia Bank Ltd (NAB)
NAB could have saved $2.3bn in investment and restructuring spend by forsaking its accelerated strategy, and this may have kept the market on its side for a while. Instead, NAB has taken a long term view to create a bank of the future and the only way to preserve its competitive advantage especially in business banking and remain a going concern is to further enhance customers’ front line experience. The investment would be over three years and is expected to generate savings of >$1.0bn p.a. by 2020. Given management’s transformation track record, we back NAB in successfully executing this strategy. Price target $34.20, Buy
Suncorp Group Ltd (SUN)
We see value emerging after rebasing its risk profile and lowering its discount rate to 10.0%. SUN’s Marketplace strategy may be a concern in the short term but the operating environment remains in far better shape for general insurers than the banks – with upside coming from rate rises and further cost-outs, and little to fear from the Royal Commission. SUN is also possibly closer to divesting its life insurance business. This is in addition to having shelved its Tower New Zealand plans and should provide a kicker to its surplus capital position – and a capital return in August cannot be ruled out. Price target $15.50, Buy
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