Australian Banks: Worse Before Things Get Better

Feature Stories | Nov 24 2021

Analysts agree FY22 will be another tough year for bank margins before sentiment begins to improve and the RBA eventually raises rates.

-Australian banks' net interest margins surprised to the downside
-Little relief apparent in FY22, but dividends not under threat
-RBA rate hikes will save the day
-Big retail banks to struggle more than smaller commercial banks

By Greg Peel

The bank reporting season has now wrapped with three of the four majors reporting full-year FY21 earnings and Commonwealth Bank ((CBA)) providing a first quarter FY22 update. Suffice to say, it was a disappointing season overall.

Yet there was a clear distinction between the performances of the two big mortgage-dominating banks, being Westpac ((WBC)) and CBA, and those of the two smaller, less mortgage-exposed ANZ Bank ((ANZ)) and National Australia Bank ((NAB)). While share price responses to the latter two’s results on the day were fairly muted, Westpac dropped -4% and CBA -8%.

Analysts agree that CBA actually posted a relatively solid performance but not one that could justify the significant valuation premium it has long enjoyed over the other three banks. For Westpac, it was just a poor result.

Mortgage Pain

A near-zero RBA cash rate and historically low bond yields out to fifteen years does not provide banks with much opportunity to profit from their basic earnings driver – the difference between what they can borrow at and what they can lend at, known as the net interest margin (NIM).

While equally low global rates have meant the opportunity to borrow in corporate bond markets at low cost, with regard deposit rates – the other prime source of borrowing – banks have been backed up to a cliff. The current everyday deposit rate is 0.01%. That’s as low as it can go unless banks decide they will charge you to deposit with them, which is not particularly attractive when inflation is running at 3%.

In other words, they can’t.

What they can do is keep their mortgage and other lending rates higher to ensure margins are protected. This would work if there were only one bank. But there’s four majors, two main regionals, and a host of other non-bank financials and fintech disruptors ready to take market share.

Competition has thus been fierce. Throw in a raging Australian housing market, and the need to retain market share if not increase it has meant rates on offer have been the battlefront, with margins the casualties.

Typically, Australians have paid more to lock into a fixed rate mortgage which removes upside interest repayment risk for at least two to four years. Standard variable rates (SVR), which shift up and down with the RBA cash rate, have usually been cheaper and more popular. But given the economic and employment uncertainty created by a pandemic that won’t go away, banks decided in FY21 to offer fixed mortgages at lower rates than SVRs, thus removing some of the bad debt risk an RBA rate hike would represent.

But Australians aren’t fools. With an RBA cash rate effectively at zero, what are the chances fixed rates could move lower still, after you’ve already locked yours in? What are the chances of rates moving higher? Confronted with this binary scenario, Australians rushed to lock in their mortgages on fixed rates – some 40% of new mortgages.

Which means it is the banks that will have to wait two to four years before they can adjust to any RBA rate hike in that period.

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