ANZ: Big Four Bank - The Efficiency Problem
ANZ: Big Four Bank - The Efficiency Problem
In a Nutshell
Executive Summary
In a Nutshell
ANZ is Australia's fourth-largest bank, providing retail and commercial lending alongside institutional banking services across Australia, New Zealand, and the Pacific. At A$39.63 versus fair value of A$21.40, the stock trades 85% above intrinsic value. The bank has the weakest operational efficiency of the Big Four majors, with costs consuming 54% of income compared to peers at 44-48%, while net interest margins compress despite elevated rates as broker competition intensifies.
Investor Profiles
| Profile | Rating | Rationale |
|---|---|---|
| Income | ★★☆☆☆ | The 4.2% fully franked yield appears attractive, but the 85% payout ratio reflects trough earnings rather than sustainable income generation. Dividends held flat at 166 cents per share despite falling profits signals capital constraints from the Suncorp integration. Normalised payout of 70% supports current dividends, but growth prospects are limited as return on equity sits at 8.1%—well below the cost of capital. |
| Value | ★☆☆☆☆ | The stock trades at 1.82 times net tangible assets versus fair value of 0.95 times, representing an 85% premium to fundamental value. Even in the base case scenario (70% probability), downside of 44% exists to A$22.30 per share. The apparent cheapness at 17x price-to-earnings masks a business earning 8.1% return on equity against a 10.5% cost of capital—the market prices quality improvements that our analysis does not support. |
| Growth | ★☆☆☆☆ | Operating income growth of 2.3% per annum trails nominal GDP as net interest margins compress structurally from broker disintermediation. The Suncorp acquisition adds scale but dilutes returns, with the combined entity's efficiency ratio worsening before gradual improvement. Earnings per share recover mechanically in FY26 as one-off costs fade, but this represents mean reversion rather than genuine growth—beyond FY27, wage inflation outpaces revenue gains. |
| Quality | ★★☆☆☆ | Business quality scores 5.7 out of 10, materially below the peer average of 7.3. The regulatory moat protects ANZ's existence within the oligopoly but not its competitive position—it ranks fourth of four majors on both efficiency and returns. Capital strength is adequate with Common Equity Tier 1 at 12.0%, and the institutional franchise provides differentiation, but the digital platform lags Commonwealth Bank materially. |
| Thematic | ★☆☆☆☆ | The Australian banking oligopoly faces structural headwinds rather than tailwinds as broker disintermediation, open banking, and deposit transparency compress margins industry-wide. The ability to translate rising interest rates into higher earnings has broken—ANZ's net interest margin fell 9 basis points in FY25 despite the Reserve Bank holding rates at 3.85%. Late-cycle positioning with emerging credit stress signals a difficult environment ahead. |
Best fit: None at current price. The stock suits value investors only if it falls below A$22, where downside becomes limited and the oligopoly floor provides protection. At A$39.63, even the base case scenario delivers negative returns—the market's 85% premium to intrinsic value assumes either a structural improvement in returns that ANZ has never demonstrated, or assigns an oligopoly premium that fundamental analysis cannot justify.
Executive Summary
ANZ earns money by borrowing short (customer deposits) and lending long (home loans, business credit), capturing the spread as net interest income. The institutional division provides transaction banking, foreign exchange, and trade finance across Asia-Pacific. This basic banking model generated A$22.2 billion in operating income during FY25, with 82% from net interest income and 18% from fees and markets revenue.
Recent performance was poor. Cash profit fell 14% to A$5.8 billion as the bank absorbed A$1.1 billion in significant items—redundancy costs, technology migration expenses, and a A$240 million regulatory penalty. The Suncorp acquisition added A$73 billion in home loans but diluted efficiency, pushing the cost-to-income ratio from 52% to 54%. Net interest margins compressed 9 basis points despite elevated rates as broker competition intensified.
The investment case centres on whether the Suncorp integration can transform ANZ from the weakest Big Four member into a credible competitor. Management expects costs to improve as one-off expenses fade and synergies deliver. Our analysis finds that even successful execution lifts return on equity only to 9%—below the 10.5% cost of capital. The oligopoly protects ANZ's existence but not its returns. At A$39.63 versus fair value of A$21.40, the stock is 85% overvalued.
Results & Outlook
What happened?
FY25 was a transition year dominated by integration costs. Cash profit of A$5.8 billion included A$585 million in redundancies, A$240 million in ASIC penalties, and A$285 million in other one-offs. Strip these out and normalised earnings were A$6.9 billion—flat year-on-year. The Suncorp Bank acquisition added A$6.2 billion in shareholders' equity but generated only A$400 million in profit during its five months under ANZ ownership. Net interest margins fell from 2.35% to 2.26% (excluding markets) as mortgage brokers captured 70% of new home loan flows, forcing pricing down.
| Metric | FY24 | FY25 | FY26E | FY27E |
|---|---|---|---|---|
| Operating Income (A$M) | 20,809 | 22,200 | 22,700 | 23,400 |
| Cash Profit (A$M) | 6,725 | 5,787 | 7,070 | 7,245 |
| EPS (cents) | 224 | 195 | 237 | 244 |
| Cash ROE (%) | 9.7 | 8.1 | 9.6 | 9.5 |
| Cost-to-Income (%) | 51.6 | 53.8 | 52.5 | 52.0 |
| NIM ex-Markets (%) | 2.35 | 2.26 | 2.26 | 2.24 |
What's next?
FY26 brings mechanical recovery as the A$1.1 billion in one-off costs disappear. Cash profit should reach A$7.1 billion—a 22% increase that requires no operational improvement. The cost-to-income ratio improves to 52.5% as restructuring expenses drop, then peaks at 52.0% in FY27 as Suncorp synergies flow through. Beyond that point, wage inflation (rising at 4% annually on a A$6.5 billion personnel base) outpaces revenue growth, pushing efficiency back toward 53%.
The May 2026 half-year result will prove decisive. Investors need to see Suncorp's standalone cost-to-income ratio fall below 55% to validate the integration thesis. Net interest margins face structural pressure—each 5 basis point decline erases roughly A$390 million in annual net interest income. Credit losses are normalising from an unsustainably low 5 basis points toward the through-cycle average of 12 basis points, adding A$600 million in annual charges. The Reserve Bank's rate path matters, but cannot offset structural competition from brokers and non-bank lenders.
Valuation & Risks
| Metric | Value |
|---|---|
| Fair Value | A$21.40 |
| Current Price | A$39.63 |
| Downside | -46% |
| 90% Confidence Interval | A$14.98 – A$27.82 |
The biggest risk is structural net interest margin compression. ANZ's margin excluding markets fell 9 basis points in FY25 despite the Reserve Bank holding rates at 3.85%—a pattern that breaks the historical relationship where rising rates lifted bank margins. Mortgage brokers now control 70% of new home loan flows and rising, commoditising lending and forcing price competition. Deposit customers have become rate-sensitive through comparison websites and open banking. Each 5 basis point decline in net interest margin erases roughly A$390 million in net interest income, or 5% of cash profit.
This compression is structural, not cyclical. Even if the Reserve Bank cuts rates, banks cannot widen margins materially—the power has shifted to brokers and depositors. We assign a 30% probability that net interest margins fall below 2.15% within two years, which would reduce fair value by approximately A$2.50 per share. Commonwealth Bank's superior digital platform and branch network provide partial insulation from this trend; ANZ lacks such defences. The market appears to price either a reversal of structural trends or permanent oligopoly rents that exceed what the business model can sustainably deliver.