Eyes on the big Australasian banks' profits and whether they pass on any Reserve Bank of Australia rate cut in full

By Gareth Vaughan

Big bank financial results have swung back into focus with BNZ's parent, National Australia Bank (NAB), issuing a first quarter trading update today amid talk of the big Australian banks not passing on to customers in full an expected interest rate cut by the Reserve Bank of Australia (RBA).

But the expectations are the banks will maintain their healthy dividend payouts to shareholders.

NAB reported an 8% rise in quarterly cash earnings to A$1.4 billion. Westpac Banking Corporation and the ANZ Banking Group, which also have September 30 balance dates, will release quarterly trading updates - next week - on February 16, and February 17, respectively. ASB's parent Commonwealth Bank of Australia (CBA), which has a June 30 balance date, will release its half-year financial results for the six months to December 31 on Wednesday, February 15.

The results come against a turbulent global economic backdrop headed by the Eurozone sovereign debt crisis, job cuts from Westpac in Australia and an expectation that the big Australian banks won't pass on in full an expected 25 basis points cut to Australia's official cash rate, currently 4.25%, by the RBA today. Any stand-off over whether an Aussie rate cut is passed on is likely to run until at least Friday when ANZ is due to reveal the results of its monthly review of housing and small business floating interest rates.

Sector pressures

CBA's first half-year result will reflect the banking sector pressures of weak asset growth and margin pressures as funding costs rise, analysts at Macquarie Equities say, although dividend payouts from the big four Australian banks are expected to be sustained or even increased.

"The CBA result is the bellwether for the sector," say Macquarie analysts Michael Wiblin and Cameron Pierce in a research report previewing the results.

"We expect the result to show sector pressures with soft margins driven by competition for assets and higher funding costs and asset growth reasonably anaemic."

"Commentary will be reasonably muted given sombre domestic economic conditions. Investors should look for indications of the possible direction of CBA's strategy from new CEO Ian Narev (who replaced fellow New Zealander Ralph Norris in December). While this is likely to be centred on being the 'lowest cost' and 'most innovative' provider in the market, any growth aspirations are likely to be closely viewed," add Wiblin and Pierce.

The Macquarie analysts predict half-year cash net profit after tax at CBA of A$3.62 billion, up 3.4% and an interim dividend of A140 cents per share, up 6.1%. However, they expect net interest margins to contract by 4 basis points versus the second-half of the last financial year due to "elevated" funding costs, higher liquid asset balances and retail banking competition.

They note recent moves by the major banks show their funding markets are open but expensive, and say ongoing deleveraging by bank customers should help sustain dividends because it releases capital. The big four banks have a combined dividend yield of 7.2%.

Last year the big four Australasian banks made record combined A$25 billion profit. However, credit growth in Australia has fallen to its lowest level since the 1970s as households improve savings and companies deleverage. Credit growth, where there is any, is also anaemic in New Zealand. Reserve Bank sector credit figures show housing debt up 1.2% in 2011 to NZ$172.985 billion, and business debt up 1.7% to NZ$73.718 billion. Agriculture debt fell 0.5% to NZ$47.332 billion and consumer debt dropped 0.3% to NZ$11.840. 

ASB coming off a strong June 2011 year & strong first quarter

For the six months to December 2010, the ASB group, including insurer Sovereign, posted a NZ$107 million, or 58%, jump in cash net profit after tax to NZ$293 million from NZ$186 million in the same period of 2009. The 2009 half-year result included a NZ$209 million provision for the structured finance transaction dispute with the Inland Revenue Department.

The increase in ASB's first-half profit in its last financial year was also bolstered by a 71.6% drop in impairment costs to NZ$36 million, and 24% rise in net interest income to NZ$540 million.

ASB ultimately delivered a record annual net profit after tax of NZ$568 million in the year to June 30, 2011, paying CBA NZ$280 million in dividends. Its General Disclosure Statement for the first quarter of its current financial year, showed an 18% rise in September quarter profit to NZ$177 million as its lending book contracted.

Pass it on?

Meanwhile, the Macquarie analysts predict the big four Australian banks will decide not to pass on between 5 and 10 basis points of the next RBA rate cut in a move that's bound to court the wrath of Australian politicians. They note CBA's recent A$3.5 billion five-year Australian covered bond issue was cheaper than recent overseas ones by Australian banks costing 175 basis points over the bank bill rate compared with the 220-245 basis points cost of overseas issues. However, it appears to have ensured higher funding costs are "baked into the domestic market" with secondary unsecured spreads "blowing out" after the deal's completion.

Nonetheless, the mammoth CBA issue was followed by a A$3.1 billion five-year Westpac issue proving there was "more than adequate" demand for domestic Australian covered bond issuance.

Wiblin and Pierce suggest that if the big four Australian banks issue their total regulated covered bond limits this year, which is 5% of their total domestic assets, NAB would cover 60% of its 2012 funding requirement, CBA 64% of its, Westpac 74% of its and ANZ 76% of its. Covered bonds are secured by residential mortgages written by the bank issuer. See more on covered bonds here.

"Given the recent covered bond issues, the depth of the domestic government bond market versus the covered bond limit at A$370 billion versus A$80 billion, and an emerging increase in demand for Australian dollar assets, it may be the majors continue to issue covered bonds domestically."

BNZ's 'expensive' covered bond issue

The only New Zealand bank to issue covered bonds so far this is year is BNZ, which raised NZ$225 million through a six-year private placement to domestic institutional investors and €500 million through a three-year issue to European institutional investors which CEO Andrew Thorburn told interest.co.nz cost about 250 basis points above the bank bill rate.

In another research report Australian-based banking analysts at Merrill Lynch note 2012 brings two "inveterate threats" for the big Australasian banks of wholesale funding exposure and falling house prices, alongside several micro-factors such as consumer deleveraging, small and medium sized business credit quality concerns, transition to a new liquidity regime with the slow introduction over several years to the Basel III global banking capital requirements, and a potentially hostile government to the banks' increasing interest rates charged to their customers.

According to Deutsche Bank analysts, ANZ's wholesale funding requirement this year is A$17 billion, Westpac's A$21.3 billion, CBA's A$22.7 billion and NAB's A$26.6 billion. See more on this here.

The Merrill Lynch analysts rate ANZ their top stock pick among the Australian banks saying in a tough wholesale funding market it has the lowest funding gap, the best exposure to opportunities in the syndicated lending market, an improving outlook for its Asian business and New Zealand cost cutting benefits should emerge this year.

Overall Merrill Lynch forecasts the Australian banks to deliver 1.5% earnings per share growth this year and 2.5% next year.

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