Australian Banks: More De-Rating Ahead?

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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

Australian bank shares underperformed a weak ASX200 in February. Could this be the beginning of a long-awaited de-rating cycle?

-Banks underperformed post trading updates in Febuary
-PE multiples already considered too high prior
-Earnings risk still seen as to the downside
-Might a de-rating cycle have started in 2025?

By Greg Peel

The recent stock price correction across Australia’s major banks over the last two weeks of February came as a surprise to Citi, given updated earnings performances were largely in line with expectations. One might be quick to argue, nonetheless, that banks fell in line with the market in general, as the ASX followed down Wall Street.

However, as Morgan Stanley points out, the average total shareholder return (share price move plus dividends) of the major banks fell -5.4% in February when the net ASX200 equivalent fell by only -3.8%.

Movements were mixed across the majors. Perennial outperformer Commonwealth Bank’s ((CBA)) total return fell only -1.0%, Morgan Stanley notes, compared to ANZ Bank’s ((ANZ)) -2.7%, Westpac’s ((WBC)) -5.7% and National Bank’s ((NAB)) -12.1%.

The spread among the smaller banks was even more stark. Judo Capital ((JDO)) actually grew its TSR by 0.5%, compared to Bank of Queensland ((BOQ)), down -3.9%, and Bendigo & Adelaide Bank ((BEN)) down a standout -19%.

In pure and plain naked share price movements, CommBank shares have now lost -11.5% in less than one month, with Westpac shares down by a similar magnitude, while shares in ANZ Bank and NAB both lost about -7% since.

Were the banks simply overpriced?

Multiple Issues

On a relative price/earnings multiple basis, the banks troughed in June 2023, UBS’ Australian-based analysts note, post the collapse of Silicon Valley Bank in the US and the bail-out of Credit Suisse by Swiss compatriot bank UBS, with sentiment at a peak period of pessimism after the yield curve inverted (suggesting a potential recession ahead).

Recession fears in the US persisted through 2022 and into 2023 as inflation soared, but petered out in 2024 as US economic growth surprised to the upside.

From that trough the banks rallied from a low base, and since October 2023 the sector has been a strong outperformer, up over 30%, driven by PE multiple expansion, leaving it looking, to UBS and many others, overvalued.

Having peaked at record high PE multiple of an average 19.2x in January, Australian majors fell back to 18.2x in February, Morgan Stanely notes, or 14.5x ex-CBA.

At the start of the year Morgan Stanley suggested in its 2025 outlook report that earnings expectations and trading multiples set a very high bar for Australia’s banks in 2025, with little margin for error. The sector’s share price underperformance in February suggests recent results (half-year for CBA, first quarter for ANZ, NAB and Westpac) and trading updates were not good enough to meet lofty expectations or to support the elevated trading multiples.

Specifically, Morgans Stanley thought market updates fell short in two key areas: net interest margin movements were relatively small in the December quarter but the trends were weaker than forecast; and capital levels were lower than expected, leading to less conviction on the size and timing of future buyback announcements.

Banks and Rate Cuts

When the RBA hikes its cash rate, the banks typically pass on the hike in full to mortgage rates, but not so to deposit rates. Retirees relying on interest income have long decried this reality, but, at least as far as politicians are concerned, mortgage holders have the louder voice. Riling retirees even more this time around is the banks immediately passed on February’s -25 point cut to mortgage rates, and also to deposit rates.

Lifting mortgage rates by more than deposit rates increases banks’ net interest margins (NIM), the sector’s earnings bread and butter which arguably protects against lower mortgage and general loan demand at higher rates, as well as possible loan defaults. Rate cuts threaten bank NIMs, while at the same time increasing loan demand and easing default risk.

It’s a delicate balancing act.

Rate cuts have historically led to an acceleration in the housing market and housing credit growth, Macquarie notes. With the RBA February cut well anticipated, the housing market is already showing signs of recovery, with prices lifting in February after four months of flat-to-falling prices.

But this time it’s different, Macquarie takes the risk in suggesting. It’s early days, but the broker expects the macro tailwinds from rate cuts to be more muted this cycle given they have already been significantly front-loaded, a relatively modest easing cycle is likely ahead, and borrowers already face very stretched housing affordability.

Indeed, Macquarie forecasts housing credit growth to moderate from around 6% (annualised) to around 5.6% by the end of 2025. The early response from the housing market nevertheless suggests some upside risk, the broker admits.

It must be said that for several years now, economists have clearly underestimated the upside for Australian house prices and mortgage demand in both positive and negative economic climates, while clearly over-estimating house price falls during negative times.

It also must be noted an RBA rate-cutting cycle that many have been hoping for for some time, and for many is still assumed, may not be a given. Inflation has come down but is struggling in the “last mile”, while unemployment remains stubbornly low, as far as the RBA is concerned.

Looking (with trepidation) across the Pacific, the US Federal Reserve delivered two rate cuts (or three on a -25 point basis) and many more were expected. But now the Fed is on hold due to fiscal policy uncertainty, notwithstanding the US CPI actually ticked up in January, which can’t be blamed on Trump.

The RBA flagged at its last meeting, which delivered a -25 point cut, it is likely on hold now as well.

One driver of inflation that refuses to fall as fast as hoped, on either side of the ocean, concerns insurance premiums. The dominant driver of rising premiums is the cost of major natural catastrophes. It is feared Tropical Cyclone Alfred may yet prove Australia’s most costly event more so than the devastating 2019-20 bushfires given the sheer population density impacted. In the US, the Los Angeles fires are a similar case in point.

Mortgage Amortisation

When the RBA cut rapidly to as good as zero during covid, a record number of Australians locked in record-low fixed mortgage rates being offered in desperation by the banks. But they did not necessarily reduce their weekly payments commensurately, meaning they could pay back their mortgages faster.

This “mortgage amortisation” weighed on credit growth, Macquarie explains, another headwind to bank earnings in a rate-cutting cycle.

But if we are in another “cycle”, will the same be the case this time? Possibly not, says Macquarie. Headwinds will likely be smaller this cycle given cost of living pressure and record-high mortgage repayments, hence more households may reduce repayments this time around.

Indeed, the media has reported that bank call centres have been flooded with customers seeking to reduce their repayments in the wake of the RBA cut. If around 50% of borrowers were to reduce their repayments to the minimum, it effectively reduces the drag on credit growth from lower rates, Macquarie notes.

Not all banks automatically adjust minimum repayments. Customers of ANZ, CBA and NAB will all need to contact their bank to reduce their repayments, while Westpac customers who are already making the minimum repayment will have their repayments automatically reduced to the new minimum. Macquarie estimates over 40% of customers might be making minimum repayments.

Another balancing act for the banks.

Downside

Over the next year or so, the bank sector faces several headwinds, Citi warns.

Net interest margins are likely to compress as funding costs are likely to remain high. Relief from easing default risk as rates fall may not eventuate if RBA rate cuts are gradual and households continue to face cost of living pressure.

Another headwind, Citi suggests, is attention needs to be paid to bank capital positions. The recent reporting season showed bank CET1 ratios below expectations, which brings into question the capacity for future share buybacks and/or dividend payouts.

Overall, Citi sees downside risks to consensus earnings forecasts, which may make it hard for banks to outperform, especially given current lofty valuations. The broker maintains an Underweight view on the sector and expects stock prices to remain under pressure as downside catalysts play out.

As noted, Morgan Stanley believes the banks’ latest results were not good enough to meet lofty expectations or to support elevated trading multiples. This broker too retains a negative stance on the major banks and expects them to underperform the ASX200 in 2025.

With bank earnings upgrades potentially reaching their end, even ahead of the impact of lower rates, it appears to Macquarie the long-awaited de-rating of the sector may be here.

Hindsight is a wonderful thing, the broker admits, but looking back, this de-rating was long coming given stretched valuations, limited-to-no earnings growth, and crowded positioning (especially for NAB and Westpac), which ultimately led to outsized share-price moves relative to earnings.

Following the RBA’s expected February rate cut, Macquarie expects the market to continue to focus on margin expectations, which the broker believes are too high and likely to lead to further share-price headwinds.

Macquarie sees further downside risk to consensus earnings and margins in FY26 as the impact of rate cuts flow through to margins.

(CBA’s FY25 ends in June, the other three in September.)

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
SUN	3/3/0	19.30	20.55	6.46	2.0	2.4	83.0	4.9	2.4	– 11.7	71.6	4.3
JDO	3/2/1	1.93	2.15	11.23	23.3	N/A	0.0	0.0	53.7	N/A	0.0	0.0
MQG	2/2/1	208.09	225.71	8.47	7.2	– 2.3	63.6	3.0	12.7	15.3	65.1	3.5
NAB	1/1/4	34.24	33.12	– 3.29	– 0.1	0.7	75.8	5.0	1.4	0.0	74.8	5.0
WBC	1/0/5	30.54	29.70	– 2.74	– 0.9	– 6.6	77.9	5.1	1.9	1.4	77.5	5.1
ANZ	0/4/2	28.75	28.17	– 2.03	7.5	3.6	73.4	6.0	1.0	0.4	73.0	6.0
BEN	0/2/3	10.38	10.49	1.06	– 16.0	– 1.8	76.4	6.0	– 2.3	0.6	78.7	6.0
BOQ	0/1/5	6.43	5.90	– 8.29	18.6	3.7	68.5	5.5	14.4	9.7	65.7	6.0
CBA	0/0/6	148.68	107.46	– 27.73	7.6	3.4	78.8	3.2	3.3	3.2	78.7	3.3

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