Australian Banks, Bad Debts And The Budget

Feature Stories | 10:00 AM

The March quarter turned sour for the banks and bad debt provisions were increased, ahead of a federal budget that will have significant impact on mortgage demand.

• Banks revenue growth turns negative in the March quarter
• Provisions against bad debts topped up in weak macro environment
• Tax changes in the budget will undermine property investment
• Even after share price weakness, questions remain about (in)appropriate valuations

By Greg Peel

Early this year, bank share prices were on a tear. The average major bank total shareholder return (capital gain plus dividends) of 12.5% in the month of February was significantly better than the ASX200’s 4.1%. Commonwealth Bank ((CBA)) led with 18.5%.

In February, CBA reported first half earnings while ANZ Bank ((ANZ)), National Australia Bank ((NAB)) and Westpac ((WBC)) provided December quarter numbers and updates on the month of January.

Following a positive reporting season, Morgan Stanley suggested the banks’ earnings upgrade cycle, solid balance sheets and low risk profile would continue to support investor interest.

The RBA implemented its first rate hike in February. While bank PE multiples typically de-rate during an RBA hiking cycle, Morgan Stanley believed recent results were likely to keep valuations elevated in the near term.

Morgan Stanley also believed the sector was late in its outperformance cycle, with de-rating risks rising as the year unfolds.

Emerging stumbling blocks were identified as downside risks to the economy, loan growth and credit quality from the combination of monetary and fiscal policy pivots, the potential for another outbreak of competition as the five largest banks try to implement their strategies, and execution risks around transformation and productivity agendas.

The broker thought elevated expectations and multiples skewed the risk toward underperformance versus the ASX200 in 2026 rather than another year of outperformance.

Then at the end of February, Trump bombed Iran.

May Results

This month, ANZ, NAB and Westpac released first half FY26 results (September year-end) while CBA and Macquarie Group ((MQG)) provided a March quarter update.

The fact the RBA chose to hike at its February meeting, pre-war, indicated inflation was already sticky and indeed creeping up again. The RBA has since chosen to Implement two more rate hikes, thus wiping out the three prior cuts that signalled the end of the post-covid inflation surge.

Inflation is now rising again, suggesting more rate hikes to come. But the inflation caused by the spike in fuel, fertilser and other prices and the subsequent flow-through to the general economy is supply-side inflation, not typical demand-side inflation which drives a strong economy and prompts the RBA to cool things down with a rate hike.

Supply-side inflation threatens a weaker economy, which is why another rate hike at the RBA’s June meeting is not considered inevitable, even if inflation readings continue to rise as expected.

Following the March bank reporting season, the outlook for Australian banks has become more challenging, Ord Minnett suggests, prompting a less constructive sector view.

The shift in sentiment reflects a marked change from the February reporting season. At that time, banks delivered strong revenue growth and benign asset quality, leading to consensus revenue upgrades and lower expected credit impairment charges.

The subsequent May reporting season told a different story. Revenue growth stalled, asset quality indicators began to soften and banks moved to rebuild collective provisions. As a result, consensus earnings per share downgrades have effectively unwound the earlier upgrades.

Two clear themes emerged, Ord Minnett notes. First, revenue growth has decelerated across all major banks, even after adjusting for markets income volatility and day-count effects (fewer working days in the quarter).

Second, quarterly outcomes are proving highly volatile, reinforcing the risk of extrapolating short-term trends. Aggregate quarterly revenue growth for the major banks fell from a strong December quarter to flat in the March quarter, with all institutions experiencing a noticeable slowdown.

Macquarie agrees in a sharp turn from the December quarter, banks showed softer trends in March.

Revenue growth was weaker, falling -0-5% quarter on quarter, after rising 1%-4% in the December quarter. While better cost management partly offset this weakness, pre-provision profits fell -1%-9% quarter on quarter. Volatile markets income and FX contributed to softer revenue outcomes, but with lending competition increasing and downside risk to volumes, Macquarie expects revenue trends to remain challenging ahead.

Underlying margins were softer than expected, Macquarie notes, mostly holding flat, while lending competition stepped up.

With downside risk to volumes, and ANZ Bank looking to return to growth, Macquarie expects lending competition to remain intense. Higher rates will provide some tailwinds to margins, but this is now largely built into expectations.

Expenses were generally well managed across the banks, Macquarie notes, with underlying expenses down -9 percentage points to 2%, albeit this was supported by a weaker New Zealand dollar.

ANZ and Westpac both increased productivity goals for FY26 as they sought to target better tier one capital. While there is scope for expenses to continue surprising positively, with ongoing inflation and IT transformation programs, Macquarie thinks this is insufficient to offset near-term risks to revenues.

Banks elected to top up provision coverage (against bad debts), other than ANZ. Credit quality trends were mixed, with continued improvements at ANZ and Westpac, but some deterioration in non-performing business loans at NAB and CBA.

With a challenging macro outlook likely to continue, Macquarie continues to see upside risk to bad debts in the near term.

Credit conditions remain sound, supported by low unemployment and resilient property prices, but early signs of stress are emerging in certain corporate exposures and personal lending.

Hence, banks have prudently, in Ord Minnett’s view, increased collective provisions, particularly as reliance on internal credit risk modelling has grown following Basel 3 changes.

Overall, brokers have made minor earnings forecast changes, yet current sector multiples don't yet fully reflect a sector in transition, in UBS’ opinion, moving away from a benign credit and interest rate tailwind environment to one of rising provisions, slowing mortgage growth, and policy adjustments.

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