In Brief: Banks, Technology & Insurance

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Weekly Broker Wrap: Australian bank outlook; technology insights from US companies & rising conduct risk for insurers.

-The outlook for Australian banks
-Jarden’s technology insights from the US
-Conduct and regulatory risks rising for insurers

By Mark Woodruff

The outlook for Australian banks

Despite an around 400 basis point rise in average borrowing costs, the Australian mortgage market is outperforming Citi’s expectations in both credit growth and asset quality terms, making it difficult to form a near-term bear case.

Asset quality associated with mortgages is expected to remain benign for Australian banks and demand for new mortgage debt should be elevated.

Moreover, new Federal and Victorian government housing policies aimed at improving affordability should stimulate housing demand, according to Citi. National Cabinet has announced a plan to build 1.2 million new  homes over five years from July 1 2024. That is a run-rate of 60,000 per quarter, which Morgans notes has rarely been achieved.

These policies have also highlighted the difficulties the housing market has in accommodating the rising immigration required to meet growing labour needs, notes Citi.

Such policies will encourage the construction of new housing, resulting in more labour shortages, additional wage inflation and increased property demand, suggests the broker.

In looking at a potential real estate up-cycle resulting from the Federal government housing plan, Morgans identifies potential beneficiaries on the ASX.

The broker's list is split between raw input products – Adbri ((ABC)), Boral ((BLD)) and Wagners Holding Co ((WGN)) – refined products – Brickworks ((BKW)), CSR ((CSR)), Reece ((REH)) and James Hardie Industries ((JHX)) – building/development services – Acrow Formwork and Construction Services ((ACF)),  REA Group ((REA)) and Qualitas ((QAL)) – real estate developers – Cedar Woods Properties ((CWP)), Maas Group ((MGH)), Peet ((PPC)), Mirvac Group ((MGR)) and Stockland ((SGP)) and discretionary retailers – Beacon Lighting ((BLX)) and JB Hi-Fi ((JBH)).

Qualitas and CSR are Morgans preferred exposures from the above list.

In September, mortgage spreads remained stable, according to Macquarie’s Lendi Mortgage Pricing Index, which further suggests competition has remained stable.

Westpac ((WBC)) is still the most competitive on mortgages, notes Macquarie, while CommBank ((CBA)) is the least aggressive on pricing, resulting in an accelerating mortgage book reduction, according to APRA volume growth data.

Both Westpac and ANZ Bank ((ANZ)) continue to gain meaningful mortgage market share, while Commbank’s mortgages have regressed. Citi highlights Westpac has been a key beneficiary by growing its mortgages by $8.6bn over the past three months, eclipsing both ANZ and Macquarie Group ((MQG)). 

Citi attributes the current market share shifts to the respective timing of cashback removals, with CommBank having led the market in May. Broker and bank feedback suggests this drove incremental demand to peer banks who continued to offer cash-backs for a few more months.

Commbank also lost market share due to a conscious decision by management to increase its pricing to reduce flows, suggests the broker.

CommBank will be unwilling to cede market share, points out Macquarie, leading to a return of some level of mortgage competition for the industry. 

Citi disagrees with this view, as CommBank has been hampered by funding constraints which remain. Apart from a record $68bn of wholesale maturities due in FY24, there has been a slowdown in deposit momentum, explain the analysts.

Around a week ago, Macquarie downgraded its Bank sector view to Underweight, given both revenue and expense headwinds, and nominated Neutral-rated National Australia Bank ((NAB)) as it’s preferred exposure.

Despite some valuation support, the broker sees ongoing revenue challenges from margin compression on both mortgages and deposits. Also, it’s thought the market hasn’t as yet factored in meaningful expense headwinds.

By contrast, Citi see relative outperformance for the banks over other sectors. 

This broker prefers ANZ Bank (Buy), followed by Neutral-rated Westpac and NAB, while CommBank has a Sell recommendation.

For the regional banks, Citi prefers Bendigo & Adelaide Bank ((BEN)) over Bank of Queensland ((BOQ)) though both are assigned a Neutral rating due to the challenging operating environment.

Deposits have remained volatile in the new financial year, explains Macquarie. Westpac continues to lead peers in household deposit growth, with an around 10% lift over the past three months, while Bendigo & Adelaide Bank has grown its deposit book by circa 14% over the same period.

Thanks to a slowdown in lending growth over the last few months, the funding gap that had arisen between lending and deposit growth has closed, thereby reducing the pressure on deposit pricing, explains Citi.

Jarden’s technology insights from the US

Having returned from a series of meetings with US-listed tech companies, start-ups and entrepreneurs, the analysts at Jarden provide new insights relevant to ASX-listed technology shares under its research coverage.

While the SiteMinder ((SDR)) share price has already risen 63% over the last three months, the analysts gained further confidence in their investment thesis after noting Airbnb is experiencing increased domestic travel in a softer economic environment.

This durability for Airbnb confirms the broker’s original view that Buy-rated SiteMinder has greater resilience relative to its more economically elastic travel peers. 

Like SiteMinder, Airbnb is aiming to increase its take-rates to existing customers, by adding services to increase its Lifetime Value (LTV) metric.

Following meetings with channel partners, the analysts continue to have concerns around the uptake of Xero’s ((XRO)) products in the US. This country has a more direct-to-market approach versus the accounting channels in the UK and the A&NZ region, where Xero has previously been successful.

In the US, the channel is 70% direct compared to 70% via accountants in Australia and the UK, explains the broker, which has an Overweight recommendation for Xero, one rating notch below a Buy in its rating system.

Jarden points out long-term margins across the US technology sector are greater than 40% for the likes of ServiceNow, Workday, E2Open, which potentially implies downside risk to consensus margin forecasts for WiseTech Global ((WTC)).

FY31 consensus margins are currently more than 60% for WiseTech or greater than 50% including capitalised R&D, notes the broker.

Of relevance to Altium ((ALU), the analysts also met with Autodesk and Cadence. Both have recently raised prices by up to 20% and noted very strong price inelasticity, which should bode well for the industry overall.

The printed circuit board (PCB) market is a small focus for these two companies, notes Jarden, which is potentially favourable for Altium.

It’s felt the company will not only benefit from limited competition but also upgrades and pricing power. However, the broker believes these positives are already incorporated into the current share price and retains its Underweight rating.

Conduct and regulatory risks rising for insurers

During 2024, investors in the Insurance sector should be wary of rising conduct and regulatory risks, according to Morgan Stanley, given it has become one of the regulator’s top focus areas.

ASIC has been increasingly active in pursuing insurers for misconduct, and the broker points out fines/court penalties have risen significantly in the last year.

This greater scrutiny stems from the Banking Royal Commission, and the enactment of the Treasury Laws Amendment, note Morgan Stanley. Subsequently, a greater range of misconduct could be pursued by ASIC and the permissible maximum penalty applicable for corporate law breaches increased substantially from March 2019

For now, the analysts still see margin expansion, positive EPS revisions and an opportunity for insurers to over-earn in a dry El Nino year. It’s also thought attractive near-term valuations will limit downside risks.

Over the longer term, Morgan Stanley suggests regulation could impact commercial lines, and for policies addressing the "loyalty tax" or price comparison, Insurance Australia Group ((IAG)) would be the most affected.

The broker explains there is risk of government action against customer "loyalty tax" or closing the gap on front versus back book pricing, in echoes of the recent Financial Conduct Authority (FCA) reforms in the UK.

There may also be further regulatory support for adoption of a Consumer Data Right in insurance. The analysts explain this gives customers greater control over their data and improves the ability to compare and switch between service providers.

Other risks identified by Morgan Stanley include explicit price control similar to compulsory third party schemes or private health insurance.

Additionally, it’s thought the government may intervene in underwriting through public risk pools, which would reduce premium pools for private insurers.

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