ANZ has released a solid set of interim results for the half year ended 31 March 2017, with cash net profit after tax (NPAT) of AUD3.41bn, up 23%. This was slightly below consensus estimates. We include a relative value assessment of its subordinated Tier 2 bonds
Management stated that the banking environment remains constrained and this was reflected in NIM which fell 6bps to 2.0%, againstestimates of -2bps. On balance asset quality remains strong, benefiting from underlying low unemployment and interest rates, although we note that 43% of all mortgages written during H17 were interest only (67% owner occupied versus 31% investor loans).
Critically, the Australian mortgage book - AUD256bn, 63% of Australian Gross Loans and Advances (GLAs) and 44% of Group GLAs) continues to perform well with loss rates of 3bps and 30% of the book three months or more in advance.
Common equity Tier 1 (CET1) increased to 10.1% from 9.8%.
ANZ subordinated debt relative value
We continue to like the risk profile of ANZ subordinated Tier 2 bonds - 10 year non call 5 (10NC5), May 2026 as a relatively defensive part of the ANZ bank’s capital structure. However with current indicative mid-mark levels of 3M BBSW + 166bps (clean price 103.868) it looks expensive with re-pricing risk (spreads moving wider) should the bank look to issue additional contingent capital in the next few months.
Investors looking for a defensive profile may find better value by switching into the shorter dated ME Bank Tier 2 10NC5 Aug 2024 with current indicative mid-mark levels of 3M BBSW + 192bps (clean price 101.734).
Source: ANZ
Regulatory capital
Regulatory capital remains the key variable for investors in the Australian financial sector, despite sound asset quality and robust cash earnings. Mindful of recent comments from APRA, the potential need to raise additional capital should not be ignored.
We keep in mind the recent speech given by APRA’s Wayne Byres (Fortune favours the strong – 5 April 2017) where he challenged the concept of what unquestionably strong means. This is evident in ANZ’s 1H17 results, where the growth in CET1 was somewhat flattered by the ongoing structural change in the lending book toward lower risk weighted asset lending, such as mortgages.
That is, whilst headline organic capital generated in 1H17 was 119bps, this included 28bps of capital generated from a shift in risk weighted assets. As such, absent the structural shift in lending, after its dividend and other payments, ANZ did not really improve its regulatory capital. There is some flexibility to be gained from divestments, and ANZ expects the announced asset sales (Asia Retail and Wealth business, SRCB and UDC Finance) to increase the CET1 ratio by 65bps to 70bps, which would effectively increase the pro-forma CET1 ratio to 10.8%. Essentially this is downsizing to grow the regulatory capital base.
Ultimately, the read through from ANZ’s 1H17 results, in my view, is that the recent concerns raised by the Australian regulators and supervisors are well founded. The Australian banks – particularly the majors – will need to increase regulatory capital bases to stronger levels, and will continue to face macro-prudential constraints for mortgage lending into the foreseeable future.