Bank Earnings Season Underway,

ANZ Overvalued?

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Three of the big four banks will report their

earnings in May. Commonwealth Bank will not

report due to June balance date for its

financial year. We at Invast prefer ANZ for the

following reasons:

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• ANZ is one of the few Australian

organisations that is legitimately leveraged

to the growth of Asian economies. It aims at

establishing business relationships and not

just braches in Asia. It’s business in Asia has

grown at a compound annual rate of

around 36% over the past few years which

is a multiple of the growth rate in the much

more mature Australian market.

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• ANZ not only has business assets in Asia but

it actually ‘gets Asia’. Compared to other

western companies, ANZ understands the

culture and the business realities in Asia.

ANZ has built its business around the Asian

market environment as opposed to

exporting its Australian bank into Asian

markets. In short, ANZ knows what it takes

to be successful in Asia.

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• ANZ understands the benefits of integrating

its Asian growth strategy into its core

Australian market. ANZ takes in

consideration the needs of their potential

clients. In fact, ANZ branch in Hurstville – a

suburb of South Sydney – is strategically

positioned with the objective of facilitating

Chinese speaking businesses. According to

the bank manager, ANZ is one of the few

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Australian banks that actually lend to Chinese

investors who wish to purchase assets in

Australia. This move is important in building

regional relationships. This is similar to how

HSBC became a global organisation with

portability in its services.

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To ensure bank credibility, a couple of things

that must be checked are margins and asset

quality. The earnings of a bank can be

distorted by many different factors. A bank’s

number can really be subject to many

elements at management’s discretion. Peter

Esho, chief market analyst at Invast, monitored

the banks during the global financial crisis. He

saw how quickly earnings can change for a

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bank based on certain balance sheet risk

items arising. The good news for ANZ is that

the loan book looks reasonable as of the end

of March this year. Impaired assets (bad loans)

as a proportion of the loan book at low at

only $3.6bn. There seems to be good

provisioning set aside for problems, individual

provisioning currently covers around $1.5bn

or 41% of all bad loans. ANZ can get away

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with it as long as things down turn sour

quickly.

One of the best ways to see where loan

quality is heading is by looking at mortgage

arrears. This is a good lead indicator for

problem loans. A loan might be in arrears but

doesn’t necessarily turn into a bad loan unless

the bank things that the chance of it being

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repaid falls below a certain probability event.

Loans which have been in arrears by more

than 90 days have actually increased from

$1.8bn in September to $2.0bn at the end of

March. We don’t know how many of these

loans are from Australia or from the Asian

business.

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Loans in arrears between 30 to 60 days rising

from $1.5bn to $2.0bn. ANZ’s total loans which

are in arrears totals $13.0bn compared to

$11.8bn at the end of September.

To put this into perspective, ANZ has only

allocated $4.3bn for all bad loans – those

which have already gone bad and those that

are in arrears but not yet in default status.

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ANZ may have reported a nice headline

growth rate in cash earnings of 11% which

caught all the news headlines BUT its loan

arrears are rising and perhaps not rising in the

Australian market which is its core business.

Eventually if the arrears continue rising and

snowball into problem loans, there will be a

need to raise provisioning and take some

pain.

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We at Invast think ANZ is well placed in the

next decade to capitalise from Asian growth.

However, we are a little cautious on the rising

arrears profile and think that eventually ANZ

will need to take some pain from a slowing

rate of growth in Asia. It might make some

bad decisions along the way have book loan

losses – that’s life in banking.

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The best way we think to value a bank is by

using a Price to Book ratio. The price the

market is willing to pay for the bank

compared to the value of equity the bank

actually owns in its business.

ANZ’s total book value (total value of its

equity) as of the end of March was valued at

$47bn. In contracts the market is valuing ANZ

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shares at approximately $93.5bn.

How do you get that? Take the ANZ share

price and multiply it by the total number of

shares on issue. The result is a Price to Book

ratio of around 2x. It’s not a big number but it

definitely isn’t cheap either. ANZ’s total

arrears make up about 30% of its total equity

value. We think ANZ probably deserves to

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to trade at a Price to Book ratio of 1.5x – 50%

premium to its equity value. This would

equate to a share price of around $25-$26.

We previously said we are willing to wait for

ANZ to fall back to around $27-$28 per share

before we start adding it to the portfolio. This

might never happen. But it’s a risk we are

prepared to take. We don’t see an immediate

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reason to buy ANZ even though we prefer it

over the other Australian banks. We will

monitor the performance of Australian banks

for the coming years and buy them if

necessary.

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To get additional information about this topic,

visit our Invast Blog today.

Disclaimer:

Please note that any advice given is general in nature past, performance is not

indicative of future performance.