Australian Banks: Expensive Havens

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Following Australian bank reporting season, is the risk for share prices now skewed to the downside?

-Bank core earnings weaker over the period
-Benign bad debts provide an offset
-Safe haven status ongoing
-Analysts cannot get past overvaluation

By Greg Peel

“Whatever the theory,” noted Citi back in April, “the common thread is that buyers look price indiscriminate, in that they are more concerned with the exposure they are avoiding (ie USD, resources, China risk, tariff risk) than the price that they are paying for Australian banks.”

Citi was referring to the period immediately following Trump’s “Liberation Day” tariffs and the turmoil they created on Wall Street and around the world. Amidst all the selling, Australian bank shares became a safe haven, and offshore investors piled in.

Trump paused those tariffs for 90 days a week later, sparking relief and a rebound on Wall Street. China was not spared, however, with Trump ratcheting his tariff up to 145%, before dropping it back to 30% and claiming victory. A 50% tariff was then placed on the EU, then paused. Most recently, a US court has blocked the original Liberation Day tariffs and the US administration has filed an appeal.

Having overcome initial panic, Wall Street has since adopted the so-called TACO trade; Trump always chickens out. And doesn’t Trump love that one. While uncertainty remains elevated, no longer does Wall Street fear the worst, and the pre-Liberation Day levels have been recovered and exceeded in the US stock market.

But not only has this not led to relieved investors moving back out of their safe haven Australian bank positions, bank share prices have done little more than continue to rise.

Why?

Australian banks collectively form the largest sector on the ASX200 by market cap. The next largest is resources. While the two sectors will occasionally move together, history reveals a common tendency to shift out of one amidst misfortune and into the other.

Long before Trump returned to office, China’s economy was on the ropes and incremental stimulus measure were failing to register. As China is the largest consumer of Australian resource sector output, commodity prices suffered from China’s downturn, and investors switched out of resources and into banks.

Wall Street might be chomping on TACOs through Trump’s flip-flopping tariff policy moves, but there is little doubt uncertainty remains. A 10% tariff on everyone may end up being the ultimate result, providing relief for penguins, but the impact on global trade would not be insignificant.

In other words, no reason (yet) to sell out of safe haven bank positions.

Rising bank share prices also become self-fulfilling. As the market cap share of the ASX200 rises (now around 23%), index-tracking funds must adjust their portfolio allocations accordingly, buying more bank shares and selling something else, such as resources.

A typical super fund is index-tracking, and flows into super funds from employees continues for now to exceed withdrawals from retirees, hence more and more needs to be allocated to the stock market, and into the biggest sector in particular.

Finally, As Wilsons points out, there are a large number of long-term retail shareholders sitting on significant capital gains from their bank positions, who thus face significant capital gains tax implications if they sell.

So they don’t.

While analysts continue to view the bank sector as “fundamentally overvalued”, with Commonwealth Bank ((CBA)) the standout, they also acknowledge all of the above.

Indeed, all agree bank valuations are currently “stretched”, “elevated”, “exalted”; choose your own word.

Result Season

Over May all of ANZ Bank ((ANZ)), National Bank ((NAB)) and Westpac ((WBC)) have reported first half FY25 earnings while CBA provided a March quarter update. Heading into result season, analysts were warning that given elevated valuations, the banks had better not post weak results.

It must be noted all the above results were to end-March, pre the worst of Trump turmoil.

The wash-up is that bank results in general were sufficiently balanced, preventing any sell-off. Indeed, bank share prices are higher still post result season.

The swing factor in any bank earnings result is “market income”, which is generated by banks’ financial market trading arms. The greater the volatility of a market in the period, the greater the opportunity to trade. Analysts consider market income as “low quality”, as it does not reflect the underlying performance of the bank, and can easily be as weak in one period as it is strong in another.

Macquarie concluded the banks’ pre-provision earnings fell -2-3% (ex-market income) in the period, underpinned by softer revenues, while headline earnings were supported by persistently low bad debt charges. The key positives in the season were strong market income and ongoing supportive credit quality. The key negatives were weaker capital and softer underlying net interest margins (NIM).

Once again, Macquarie points out, bank fundamentals showed weaker trends (excluding CBA).

Recent earnings results have frequently benefited from lower-than-anticipated bad and doubtful debt (BDD) charges, notes Bell Potter. This has often been driven by very low formation of new impaired assets and, in some cases, releases from provisions built up during more uncertain periods.

Asset quality remains broadly resilient, supported by low unemployment. Bell Potter suggests provisions held against potential future losses still appear relatively robust across the banks. Furthermore, expected RBA rate cuts should provide some relief to borrowers at the margin, potentially extending the period of benign BDD outcomes, although this must be weighed against any broader economic slowdown.

Analysts have continued to be surprised by the resilience of borrowers over past years despite the cost of living pressure brought about by high inflation, and resultant elevated mortgage costs (and general borrowing costs), which were expected to lead to increased loan arrears and ultimate loan impairments.

Looking Ahead

Sector analysts agree at current share prices, it is difficult to see any significant upside, but not difficult to see significant downside.

The caveat is the extent to which Australian banks remain a safe haven for offshore, particularly US, investors. As for domestic investors, Macquarie noted back in April super fund allocations to the Australian market were becoming full, suggesting a shift towards investment offshore.

Safe haven status will rely on what new havoc Trump might wreak on the tariff front, or if he indeed continues to “chicken out”, but there is also the matter of the US budget and Trump’s One Big Beautiful Bill.

That bill, which provides tax cuts for the rich while slashing welfare funding such as Medicaid (health insurance for the poor), has squeaked through the Republican majority House but may yet be blocked by the Republican-majority Senate. The bill would significantly increase US government debt, require a massive debt ceiling increase (all once anathema to Republicans), risking a blow-out in US Treasury yields (debt servicing is already the largest government cost) and a run on the US dollar.

Suffice to say, uncertainty, and thus risk, remains for now. In isolation, bank analysts see greater headwinds ahead for Australian banks than tailwinds.

Blowing in the Winds

One factor to consider is the aforementioned counter-relationship between Australia’s bank and resource sectors.

Improvements in sentiment towards commodities (and the mining/energy companies leveraged to them) could trigger a rotation of capital back into the currently “un-loved” resources sector, Bell Potter warns. With China currently stimulating its economy (and more relief potentially on the way) and US-China trade talks progressing positively, Bell Potter sees the potential for resources stocks to rally over the near/medium-term as global growth concerns abate.

If this occurs and sentiment towards the resources sector improves, the bank sector will be the clear funding source for many ASX investors, Bell Potter notes.

For banks specifically, recent results saw core NIMs generally declining across the banks. Intense competition continues in both lending and for deposits, Wilsons notes, squeezing margins from both sides of the balance sheet. The prospect of lower official interest rates later this year adds another headwind, likely weighing further on asset yields.

Along with this margin pressure, Wilsons is observing a distinct strategic pivot across the sector. As the home loan market becomes increasingly commoditised, the competitive battleground is shifting decisively towards business banking. NAB holds a strong incumbent position, but both CBA and Westpac are investing heavily and competing aggressively to capture market share in this potentially higher-margin segment.

While consensus has downgraded forecast FY26 profits by -1-4% through result season, Macquarie continues to see downside risk to earnings and margins. In this broker’s view, consensus is still not fully capturing the effect of lower rates on bank margins, with earnings downgrades likely as we approach FY26.

Bell Potter sees more headwinds than tailwinds for NIMs. Expected rate cuts, persistent deposit pricing pressure, and a competitive lending environment across both mortgages and business banking are likely to keep margins constrained.

Cost management also remains a significant challenge across the sector. Bell Potter warns operating expenses are facing upward pressure from broad inflation, essential technology investments (including digitisation, cybersecurity, and compliance), and wage growth. The strategic pivot towards competing more aggressively in business banking adds another layer, often requiring investment in experienced personnel which directly impacts costs.

Bell Potter views rising costs as a key risk for the sector.

Low bad debts have to date proven a safety net for bank earnings, and Bell Potter suggests low BDDs are likely to remain a tailwind for bank earnings in the near term. The medium-term outlook is nevertheless less certain, and depends heavily on the trajectory of the economy, particularly unemployment, making it a “wait and see” factor beyond the next twelve months.

Wilsons agrees low BDDs have been a godsend for the banks, and that may continue to be the case. Wilsons notes a key factor supporting the bank sector’s resilience has been its ability to broadly deliver against consensus earnings estimates, and thus offer a degree of “relative safety” amidst a challenging market earnings backdrop. But if consensus earnings momentum turns negative for the sector on the back of analyst downgrades, the banks stand to lose their “safe haven” status.

Earnings downgrades could come from a) intense competition in mortgage and business lending markets (downside risk to NIMs), b) interest rate cuts (downside risk to NIMs), or c) cost pressures. Yet with BDDs remaining subdued and the outlook for credit growth being well supported (lower rates via RBA cuts), these areas appear less likely to result in analyst downgrades, in Wilsons’ view.

However, with the Banks index trading two standard deviations above historical averages on both an absolute and relative basis, despite lacklustre earnings growth estimates, the sector is ultimately priced for a significant consensus upgrade cycle, Wilsons acknowledges.

Such an upgrade cycle is tough to envisage in the context of an RBA rate cutting cycle and intense competition from both incumbents and non-traditional lenders, both of which are likely to present headwinds to NIMs and hence earnings.

Capital Management

Attractive, fully franked dividend yields continue to be the cornerstone of the investment case for major Australian banks, particularly for domestic income-focused investors. Capital levels (CET1 ratios) remain comfortably above regulatory requirements but are generally closer to banks’ target operating ranges than in the recent past.

Combined with a potentially softer earnings outlook and ongoing investment requirements, this reduced flexibility makes large-scale, on-market share buybacks less likely going forward compared to the last couple of years. Banks are more likely to employ dividend reinvestment plan (DRP) “neutralisation” programs (buying only the equivalent of new DRP-generated shares) to manage share count dilution.

Nonetheless, while banks aim to keep payout ratios within their target bands, boards may tolerate temporary excursions above these targets if they have confidence in the medium-term earnings outlook, Bell Potter suggests.

But Macquarie sees bank capital becoming a constraint.

Capital (ex CBA) was softer over the reporting period, Macquarie notes, with weak organic capital generation and CET1 levels approaching (likely increased) capital targets of 11.75%. Further, as banks reach standardised capital floors, inorganic capital generation will also be diminished.

With headwinds from rate cuts, in addition to a possible normalisation in BDDs, Macquarie forecasts banks to not complete their existing buybacks (ANZ) and cut dividends (ANZ, NAB, Westpac).

Little Justification

Stretched valuations, especially for CBA, and a muted earnings growth outlook, keep Bell Potter cautious the sector. On a relative valuation basis, ANZ, NAB and Westpac are broadly preferred over CBA. While CBA’s quality is undeniable, again highlighted in its March quarter update, which highlighted in-line results that gave the market no reason to sell the stock, the significant premium at which it currently trades relative to its own history, and its peers, is difficult to justify.

Post the bank reporting season, Bell Potter continues to be Underweight the banks.

In light of the bank sector’s demanding headline valuation (driven by CBA) and uncompelling growth outlook, Wilsons is comfortable in retaining a “meaningful” Underweight exposure to banks. Wilsons’ preferred exposures are ANZ and Westpac, with zero exposure to both CBA and NAB.

Given underlying earnings trends and the weak revenue outlook, Macquarie also remains Underweight the sector.

If there’s one thing brokers agree steadfastly on, it’s that CBA is overvalued. But has been forever the case.

There is little debate, notes Wilsons, CBA is Australia’s highest quality bank, given its dominant position in the domestic mortgage market, strong management track-record (with notably fewer “blow-ups” than its rivals), sector-leading profitability (as measured by return on equity), and its digital/technology leadership. It thus follows that CBA deserves a premium to its ASX peers to account for its superior quality and delivery over time.

However, at a forward price to book of circa 3.6x and a forward PE of circa 27x, which is close to four standard deviations above its own long-term average, CBA’s valuation cannot be justified fundamentally in Wilsons’ view, particularly given its tepid growth outlook.

To illustrate, Wilsons notes CBA trades at roughly double the PE multiple of JPMorgan which is widely considered to be the best managed and highest quality bank in the world. This is also despite JPMorgan’s superior scale, stronger growth profile, and superior profitability.

Overall, Wilsons continues to view CBA as significantly overvalued at current levels, leaving the local market leader vulnerable to a meaningful de-rating in its valuation over the medium-term.

Yet, while brokers might agree on CBA’s overvaluation, there is little consensus as to which of the other three are preferred. As the table below suggests, the argument is only between Hold or Sell (or equivalent) ratings, with only one among the brokers monitored daily by FNArena setting a Buy rating on any of the Big Four, in this case Westpac (UBS).

The story is the same for the two main regionals, seeing no Buy ratings, while global investment bank Macquarie Group ((MQG)) and domestic disruptor Judo Capital ((JDO)) are faring noticeably better (not one Sell).

FNArena Major Bank Data					FY1 Forecasts				FY2 Forecasts
Bank	B/H/S Ratio	Previous Close $	Average Target $	% Upside to Target	% EPS Growth	% DPS Growth	% Payout Ratio	% Div Yield	% EPS Growth	% DPS Growth	% Payout Ratio	% Div Yield
JDO	4/2/0	1.44	1.92	30.39	21.7	N/A	0.0	0.0	47.4	N/A	0.0	0.0
MQG	2/3/0	209.99	211.58	– 0.56	10.6	10.3	66.1	3.4	6.8	5.3	65.2	3.5
WBC	1/1/4	31.47	28.98	– 8.43	– 2.6	– 8.3	77.8	4.8	1.1	2.5	78.8	4.9
ANZ	0/6/0	28.88	27.25	– 5.38	4.5	– 1.2	72.0	5.7	– 2.8	– 0.7	73.6	5.7
BEN	0/3/2	11.99	10.44	– 12.56	– 15.2	– 2.0	75.6	5.2	– 0.9	0.8	76.9	5.2
BOQ	0/2/3	7.79	6.38	– 17.81	26.0	8.8	67.7	4.8	5.0	5.9	68.3	5.1
NAB	0/3/3	37.34	33.17	– 11.69	0.3	0.6	75.5	4.5	0.0	0.6	75.9	4.6
CBA	0/0/6	173.79	109.25	– 36.85	7.9	3.7	78.8	2.8	2.4	2.7	79.0	2.9

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