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Australian Banks: Future Not Bright

Feature Stories | May 17 2023

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

Despite a bank result season highlighting record earnings, margins disappointed, competition is even stiffer than feared, and brokers are hunkering down.

-Banks reporting season reveals record earnings, weaker than expected margins
-Competition for mortgages more intense than expected
-Earnings downgrades follow
-Relative value improves nonetheless

By Greg Peel

The world has changed, highlights Credit Suisse (and not just for Credit Suisse). Online bank accounts mean transferring money to chase higher rates is at a click of a button. Payments are now instantaneous. Social media means money flows can move very quickly especially when confidence levels change, which begs the question: why pay a premium for a bank that is exposed to these phenomena?

Previously, bank deposits were seen as a source of lower-rate funding for banks (as opposed to issuing debt) and as “sticky”. The former is controlled by just how low banks are prepared to risk keeping their deposit rates below their lending rates as interest rates rise, and that latter harks back to the days when households chose one bank and stuck with it, and a mortgage application would require a meeting with the local bank manager.

For small businesses it required taking the local bank manager to lunch.

In more recent times, as Australians have moaned and groaned about banks not passing on rate cuts in full to mortgage rates, while passing on rate hikes in full immediately, depositors have been the forgotten Australians. If deposit rates are either cut swiftly in the first instance or raised very slowly in the latter, only a bunch of retirees get upset, and no one much pays much attention.

But as Credit Suisse points out, times have changed. Even retirees now know how to use a computer.

After decades in which loan rates, and particularly mortgage rates, have been as good as the sole focus for Australian banks and bank-watchers, suddenly the tables have turned. Not that loan rates are no longer important – they still are – but suddenly it’s all about deposit rates.

It was deposit outflows that killed Silicon Valley Bank, and deposits which led to surprise and disappointment during the recent run of Australian bank earnings reports and updates.

What Had Been Expected

Bank analysts had been well-prepared for a step-up in competition for deposits among Australian banks, as RBA rate hikes near a peak, but not prepared for just what extent said competition impacted on bank net interest margins (NIM), or the difference between borrowing (deposits and debt issuance) and lending (mortgage and other loan) rates.

As outlined in Australian Banks: Clouds On The Horizon ( ) published last month, bank analysts were warning that while the first half of FY23 (which varies for different banks) would be a cracker, thanks to the NIM opportunity provided by RBA rate hikes, bad debts remaining sufficiently low, and cuts to operating costs, it would prove a peak. From thereon, it would be all downhill.

Competition in both new loans and deposit rates would lead to falling NIMs, rising mortgage arrears (particularly given the mortgage “cliff”), lower loan demand due to rate hikes and subsequently lower earnings.

Well, they weren’t too far off, other than in their timing.

Some Perspective

Before we move to what did happen, it’s worth putting something into perspective.

As is outlined in Australian And The US Bank Crisis ( ) published in March, the US banking sector had already been suffering deposit withdrawals well before Silicon Valley Bank saw the run on its deposits which triggered the US regional banking crisis.

The reason being US banks had been even slower to hike deposit rates in the face of central bank rate hikes than Australian banks, and that in the US there are plenty of other options for “cash” investment, such as money market funds and short-term government and corporate bills/bonds.

This led to deposits simply flowing out of the US banking sector altogether.

Money market funds are almost non-existent in Australia, and there are scant opportunities to invest in short-term loans, and even if there were, our newly computer-savvy retirees would surely not know where to begin to pursue such an opportunity.

Deposits have been flowing out of Australian banks as well, but either into term deposits paying higher rates than at-call (everyday) accounts at the same bank, or into another bank simply offering higher rates. Deposits have thus remained either in the bank itself or at least within the banking system, and hence have not triggered any liquidity issues at la US banks.

Such flows have led to ever more fierce competition among banks to offer the best rates, and that’s before we get to other “disruptor” financial institutions in the mix.

What Happened

Despite expecting an impact from deposit competition going forward, bank analysts were caught about by just what impact such competition actually had on bank margins in the first half, and more specifically the deterioration in margins from the first quarter to the second.

NIMs increased by a net 14 basis points in the half, below expectations.

Already underway was stiff competition in new mortgages and other loans (front book), including incentives to borrowers such as “cash-backs”, and no change was expected here.

The banks still managed to post record earnings, as expected, and NIMs did grow over the period, as expected, but not as much as was assumed given pressures on both sides of the equation. Record earnings were supported by still-solid overall loan volume growth, but this is expected to moderate as rate rises continue to bite.

And while analysts had long been forecasting “peak” NIMs in the period, ahead of NIM contraction as RBA rate hikes impacted (with a lag), outlooks for NIMs provided by the banks were even more dour than expected.

The good news is any impact on “asset quality” – with regards to mortgage arrears and loan defaults – remained benign. Pressures are also expected to build on asset quality (mortgage cliff, possible further rate hikes) but not the extent analysts are majorly concerned about compared to the extent of capital the banks are sitting on, yet the banks still chose to top up bad debt provisions and remain circumspect about capital management in the face of headwinds.

National Australia Bank ((NAB)) was first cab off the rank in reporting earnings and the hardest hit share price-wise, after reporting record profits but disappointing with its dividend and holding back on share buybacks.

Commonwealth Bank ((CBA)) may have enough capital in the kitty to provide for buybacks, but a lower payout ratio is expected from here.

Furthermore, while competition in new (front book) loans is to ever be expected, competition has also built in existing (back book) loans, as prior fixed rate mortgages mature and become floating rate.

It’s the Wild West out there.


While the four majors are to a great extent homogenous when it comes to macro influences, they do come with distinctive individual differences. These differences have in the past led only to minor variation in forecasts, in the wider scheme of things, but this time they are more pronounced in terms of how the Australian economy will cope for the rest of 2023.

The first major difference is size, with CBA the leviathan and Westpac ((WBC)) coming in behind. The two have the greatest exposure to Australian mortgages.

ANZ Bank ((ANZ)) and NAB are the smaller of the four, with less exposure to mortgages. ANZ has the greatest exposure to institutional banking, which effectively is the opposite of retail banking, focusing on large corporates and other institutions. NAB has a greater exposure to the Small & Medium Enterprise end of business banking.

At its result release, ANZ emphasised its differentiated balance sheet skew toward its institutional business. While all banks fell short of expectations despite record earnings, due to lower than expected NIMs, ANZ’s capital position and interim dividend came in better than expected.

ANZ refrained, however, from providing an explicit margin outlook.

NAB provided the biggest disappointment on margins in its result when analysts had been more bullish, and disappointed with its dividend. Yet analysts still draw on NAB’s greater exposure to commercial banking (SMEs) and less to mortgages in suggesting this will leave NAB better placed in an economic downturn.

Clearly, bank analysts are anticipating stress in the mortgage market, more so than in business lending. Which is why the larger two banks are expected to feel more of the brunt.

That said, Westpac actually delivered the best performance among the four, showing the lowest miss on NIMs and the best earnings result against forecasts. But as far as the market is concerned, it was all about costs.

All banks have been forced into elevated capital expenditure and operating costs in recent years in order to (a), meet increased capital and tighter risk leverage requirements dating back to the GFC, (b) meet ever tighter APRA lending requirements over the years through the ups and downs of Australian housing cycles, (c) meet further tighter requirements flowing from the shock findings of the Royal Commission (albeit later eased somewhat by the then government as a response to covid), and (d) generally drag their digital systems into the internet age and keep up with fintech disruptors.

Having done the hard yards, the challenge more recently is to bring cost levels down relative to revenues, to underpin earnings. The results season just past featured a net -2.9% reduction in costs between them. Westpac has faced the toughest job in reducing its costs, hence had set a cost-cut target that analysts agreed was ambitious but positive.

Until the bank abandoned that target with its result. While Westpac delivered the best result overall, the market focused more heavily on this abandonment, and was left uncertain as to the reason why.

As the biggest, CBA has always drawn a size premium, which analysts have always fought against and have subsequently been ignored by the market. CBA only provided a March quarter update rather than a first half result, and as such did not provide a NIM number, but a lower net interest income read was enough for analysts to assume NIMs failed to hit the levels expected, as was the case with peers.

CBA is in the best capital position, and has the largest proportion of provisions, but analysts fear the bank will need such provisions given its overweight exposure to mortgages as conditions tighten.

Either way, it has always been CBA’s premium that puts it at the bottom of analyst preferences among the four, no matter what the bank does.

And as we can see from the table below, nothing has changed.

FNArena Major Bank Data FY1 Forecasts FY2 Forecasts
Bank B/H/S
Close $
Target $
% Upside
to Target
% Payout
% Div
% Payout
% Div
ANZ 3/3/0 23.54 26.49 13.54 – 4.4 11.7 68.0 7.0 – 5.1 0.3 71.8 7.0
WBC 3/3/0 21.13 23.75 13.49 29.1 13.9 69.0 6.8 – 6.4 1.4 74.7 6.9
NAB 0/5/1 26.46 27.70 5.30 10.1 10.7 71.0 6.4 – 6.9 0.1 76.3 6.4
CBA 0/3/3 97.59 89.68 – 7.38 – 4.8 12.6 72.8 4.5 – 3.8 1.6 76.9 4.5

The surprise here is that despite analysts largely implying a leaning towards the smaller, less mortgage-exposed banks, Westpac attracts three Buy (or equivalent) ratings from FNArena database brokers, and NAB attracts none.

ANZ sits atop the table but only on the slimmest of difference in upside to target, and forecast yield, such that really ANZ and Westpac are equal first, NAB third and CBA bringing up the rear as always. CBA’s size premium vis a vis earnings, combined with a below sector average payout ratio, always ensures its dividend yield falls well below peers.

Yields on the other three (fully franked) otherwise look as attractive as ever. They rely, nevertheless, on payout ratios being maintained, and despite solid capital positions, an expected earnings downturn in tough economic times may force the banks to become more capital-conservative.

Sector Views

The majors’ relative performances vary over time, providing an ardent short-term trader the opportunity to exploit valuation mismatches, but for your average longer-term investor it's easier just to buy the bloc, as your average super fund has always done.

[Those investors paying attention to details, however, know CBA is the only one in the sector that has not experienced a lost decade, nevertheless, Ed].

UBS notes (as of last week) the major banks are trading at around a 13x forward price/earnings, in line with historical averages. But not before the banks have been relative underperformers in the market year to date (-2.3% versus +4.0% for the ASX200) as investors digested the earnings downgrades flowing after CBA signalled peak NIM in October last year.

In UBS’s view, the earnings downgrade cycle for the banks may still continue, especially if pricing dynamics in the deposit or mortgage market perpetuate further.

While analysts have been warning of stiff competition ahead for deposits, as well as loans, and only more so since the SVB crisis, Citi was among many surprised by the strength and the intensity of competition in the deposit market. While the focus has been on front-book (mortgage) discounting, this reporting season made clear to Citi the scope of retention pricing (deposit rates) which has emerged as an equal, if not larger, drag.

Citi has subsequently downgraded its sector view to Neutral.

Jarden (not monitored daily) went into the results season with a Neutral view, but suggests this was, in hindsight, premature, with expected margin pressure emerging faster and stronger than expected. Given attractive relative value and a solid capital position, Jarden reaffirms its Neutral stance on the sector despite cutting earnings forecasts.

Perhaps the most notable response to the season came from Macquarie, who had held an Underweight rating on the banks for some time on the belief the first half, and particularly March quarter, would represent the last hurrah from rate hikes ahead of an economic downturn meeting stiffer competition.

With prevailing inflationary pressures, Macquarie still expects earnings and returns to decline in FY24, suggesting the near-term outlook remains challenged. However, following consensus earnings downgrades and rebased NIM expectations, the risk to earnings has moderated, the broker suggests.

While credit quality remains a potential swing factor, Macquarie sees diminished justification for being Underweight the sector as it appears more reasonably priced following relative underperformance year to date.

Macquarie thus upgrades its sector view to Neutral.

On the Matter of Buybacks

Forecast earnings downgrades are one thing, and given economic uncertainty may also lead to lowered dividend payout ratios, particularly if bad debts begin to rise, though share buybacks cannot completely be dismissed.

Morgan Stanley believes a conservative approach to capital management is warranted, but the major banks have in excess of $10bn of capital buffers under the most recent  APRA framework, and NAB and Westpac both recently stated they would consider fresh buybacks.

Morgan Stanley does not forecast any new buybacks before the second half of 2024. However, NAB recently stated it would not rule out an announcement of a new buyback in August (ahead of financial year-end), and Westpac noted it would be a "November decision" (post full-year result).

Separately, this broker believes ANZ's future capital management decisions will depend on whether the bank gets approval for its proposed acquisition of Suncorp Group's ((SUN)) bank, while CBA still has some $950,000m left of its running buyback to complete.

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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