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Managing in a downturn
We expect the banks will attempt to plug the A$7bn earnings gap
created by the credit crunch through a combination of expense and
revenue opportunities. In our view, NAB and ANZ are best
positioned and have both earnings and valuation upside.
Chart 1 : Australian banks’ earnings growth - A$6.7bn earnings gap
0%
2%
4%
6%
8%
10%
12%
14%
16%
2004 2005 2006 2007 2008F 2009F 2010F
Industry
average = 10.8%
Pre-crunch
trajectory
Post-crunch
trajectory
Cumulative
3 year profit
gap =
A$6.7bn
Source: Company data, ABN AMRO forecasts
A$7bn earnings gap between pre- and post-crunch earnings forecasts
We estimate the market dislocation has created a A$7bn earnings hole for the sector
through increased bad debts, higher funding costs and slowing loan growth versus
our pre-crunch forecasts. We believe there are expense opportunities totalling
A$1.5bn and revenue levers of a further A$1bn through a combination of offshoring,
productivity improvements and repricing.
NAB - now an expense culture, ANZ - strategic cost management
In our view, NAB's current expense execution focus gives it a head-start and,
together with further offshoring, leads to a sub-40% cost-to-income ratio in FY10F.
We believe ANZ's opportunity lies in its strategic cost management programme that
will focus on reducing management complexity but also utilise its Bangalore
operations. However, the benefits are unlikely to show until 2H09 at the earliest.
CBA - jaws to narrow in the short term, WBC/SGB - execution risk
We believe CBA is taking a longer-term view of investment by refreshing its core
banking platform. In the short term, CBA is likely to face narrowing revenue and
expense growth jaws. On the other hand, WBC faces material execution risk
regarding a successful completion of the SGB transaction.
Investment view - NAB a clear standout, upgrade ANZ to Buy
We have increased our forecasts for NAB and ANZ by 2-5%. NAB remains our standout
top pick in the sector with both earnings and valuation upside potential, in our
view. We upgrade ANZ to a Buy recommendation with its valuation sitting some 15%
below the average of the other banks and the likelihood the market will gain greater
comfort around its earnings trajectory after an expected 2H08 announcement
detailing the strategic cost programme. At current prices we see limited upside for
the likes of CBA, WBC and SGB, and retain our Hold recommendation.
Produced by: ABN AMRO
Equities Australia Ltd
S&P/ASX200: 5768.00
S&P/ASX200 Banks: 6036.14
Neutral
Sector relative to market
Sector performance
(1M) (3M) (12M)
Absolute -47.7 236.4 -1747.5
Absolute % -0.8 4.1 -22.5
Rel market % -2.8 0.3 -14.6
Source: Bloomberg
www.abnamroresearch.com
Analysts
Jarrod Martin
+61 2 8259 6086
jarrod.martin@au.abnamro.com
Michael Wiblin
+61 2 8259 5660
michael.wiblin@au.abnamro.com
Lauren Power
+61 2 8259 5039
lauren.power@au.abnamro.com
John Heagerty
+61 2 8259 6860
john.heagerty@au.abnamro.com
ABN AMRO Equities Australia Ltd, ABN 84 002 768 701, AFS Licence 240530
Level 29, ABN AMRO Tower, 88 Phillip Street, Sydney NSW 2000, Australia
Contents
B A N K S 2 6 M A Y 2 0 0 8 2
E X E C U T I V E S U M M A R Y
Managing in a downturn 3
As asset growth continues to slow, it will become increasingly important for banks
to use cost control/revenue enhancement to manage earnings. In our view, NAB
and ANZ are best placed to exploit this opportunity.
S E C T O R D Y N A M I C S
The long and winding road 8
Current conditions mean the run of strong asset growth is likely to come to an end
as the credit cycle turns. Industry profitability is likely to contract unless the
banks take action.
I N D U S T R Y D Y N A M I C S
What can the past teach us? 17
Examining the banks across three periods of slowing economic and asset growth
reveals they are masters of cost and incremental fee management, driving
acceptable shareholder returns from a slowing economy.
C O M P A N Y D Y N A M I C S
How to manage in a downturn 25
As in the past, the Australian banks have a number of levers to help manage
earnings over the next two to three years
I N V E S T M E N T V I E W
Who can best manage earnings? 31
While the sector is unlikely to be able to close the A$6.7bn earnings gap
completely, in our view, NAB is best placed to manage earnings going forward.
A P P E N D I X
Appendix – Financial summaries 44
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