- BOQ is in and not too bad - Mac Bank will probably meet guidance - For ANZ, NAB and Westpac it'll all be about margins and disaster debts - Valuations are not stretched

By Greg Peel

It was always going to be a poor first half result for Bank of Queensland ((BOQ)) given the regional impact of the Queensland floods and cyclone. Bank analysts were well prepared after a couple of profit warnings, and sure enough profit fell 41%. But at $57.6m, BOQ still managed to beat consensus profit expectation of $55m. So in that sense it was a “good” result.

BOQ had already been struggling with bad debts on Queensland commercial property before the heavens opened, and the impact to business from the weather has meant a 161% increase in bad debt provisions over the first half last year. This comes at a time when the majors have been quietly bringing excess provisions back into earnings. But the good news is that management is seeing a swift recovery – business has returned to relatively normal after only a couple of months – and no further provision increases are foreseen.

Adding to the positives were a solid increase in deposits, delivered by canoe presumably, and a rise in net interest margin – the holy grail of banking. As I write BOQ shares are up around 1.5% on the day.

The majors will not have fully escaped an impact from natural disasters either, including the Christchurch earthquake, but in the wider scheme of things they will not see anything like the specific impact felt by Queensland regionals.

For Macquarie Group ((MQG)), which reports on April 29, the story will be all about a move back to more normal trading revenues from investment banking activity. RBA Australia is expecting Mac Bank to deliver a full-year result in line with most recent guidance, meaning a 9% drop in profit from its FY10 result.

Credit Suisse will be interested to see if the Group has managed to find greater cost efficiencies, and the analysts highlight the age-old Macquarie dilemma: what split in payout does management make between staff bonuses, which are crucial in retaining talent, and dividend payments, for which a 50-60% payout ratio has been targeted?

Attention then turns to the major commercial banks, with three of the Big Four reporting half-years. Commonwealth ((CBA)) reported three months ago on its July-December cycle. The others account on an October-March basis. ANZ ((ANZ)) will report on May 3, Westpac ((WBC)) on May 4 and National ((NAB)) on May 5. RBS suggests there are several themes to keep an eye on.

Volumes on both sides of the ledger will be important given the battle that has been raging amongst all four. NAB has been pushing up its lending numbers across both homes and business and on the other side, ANZ has been winning with deposits given its Asian exposure. Both sides of the ledger combine to impact on net interest margins, which have been under pressure from rising offshore funding costs. But the out-of-cycle mortgage price increases occurred in November, and previously very competitive term deposit rates have been pulled in a bit recently.

Trading income, meaning more investment bank-like activity, has become an important swing factor for all the commercial majors over the years. As Macquarie will tell you, times have been tough of late as volumes remain low in a volatile period.

Credit growth has remained subdued ever since the GFC in business lending, and remains so still. There have been positive signs in terms of lending pipelines, but these actually have to be converted for banks to be able to grow earnings. On the home lending front, the housing market has now stalled between affordability, lack of supply and on-hold RBA rates. Improvements in net interest margins, if achieved, will point to better earnings growth ahead, but the banks still have to grow their lending books to cash in.

Bad debts have been quietly cycling down post-GFC, allowing the majors to bring large chunks of provisions back into earnings. Initial substantial provision reductions are now behind us and bad debt conditions are normalising, so the majors can't count on too much of a boost from that side from here. It will interesting to see, however, just what impact natural disasters across the country have had on bad debt growth.

Finally, the banks have being in the process of attempting to reduce costs and improve productivity. For Westpac (and CBA) this has meant expensive outlays on IT upgrades which will no doubt take time to filter through. But the banks need to reduce costs to offset the current weak lending environment.

BA-Merrill Lynch notes that net interest margin pressures have eased somewhat from both aforementioned repricing on loans and deposits, and also from cost controls. Underpinned by still significant provisions along with solid capital, margin stability sets up a solid base for earnings growth. The problem is Merrills again expects the banks to reveal disappointing follow-through on those lending pipelines, but the strategists are upbeat and feel the market is not appreciating the positives.

ANZ shares have underperformed the sector in the period on market concerns over lower profitability from lower revenues and higher costs, notes RBS. So for ANZ to reverse that trend, it has to show its margin advantage, derived from its Asian exposure, is sustainable.

Can NAB show progress in the long-term task of turning around its weak UK business? That will be a crucial factor for the bank which has seen a good earnings recovery in personal banking. Also of particular interest will be valuations on NAB's long-held “toxic assets”. In the GFC these were worth nothing on a mark to market basis, but three years later it is apparent NAB might just collect after all.

The lumbering Westpac has had a good share price run, and its focus will be on bad debt growth from exposure to disasters but also the lingering problems in the St George lending books. The bank has nevertheless shown margin improvement and Merrills is confident result expectations can either be met or exceeded.

Credit Suisse is confident the banks as a group can show improved margins, which should more than offset disaster-related bad debt growth. Merrills remains upbeat on the sector, and RBS is sticking with a sector overweight at present. But the proof of the pudding, as they say, will be in the eating.

Soon after the earnings updates provided by the banks three months ago, share prices for the Big Four were trading very close to consensus target prices (CBA was actually just over). Then came MENA, Japan and Portugal, and before we knew it gaps had opened up of 10% (15% for ANZ). Bank analysts did not change their targets as a result of global issues, so several ratings upgrades followed. Now that global problems have eased (for now), Westpac is within about 3% of its consensus target, NAB 5%, CBA 6% and ANZ 8%. Banks have underperformed resource stocks in the run back. There have been no ratings changes for the banks in the interim.

The result season will thus provide investors with possible cause to further close those gaps, or not. By the same token, bank analysts will always reassess their earnings forecasts target prices with the half-year actuals now there as concrete evidence. Moreover, we will, as always, have this lumpy business of “rolling forward” forecasts, such that the half falling off is replaced by a future half in net present valuations. Given all bank analysts are looking for margin improvement in 2011, based on funding costs peaking, business lending finally recovering and even the consumer becoming more confident, the likelihood is that targets might rise.

That is, of course, unless it is a season of disappointment.

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