Sentiment Wanes For Banking Sector

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Market sentiment for the banking sector has declined as investors struggle to balance the positive impact of rising rates on interest margins with the negative impact on the property and mortgage loan market.

-Market sentiment for banks declines as the Reserve Bank continues to issue rate hikes
-Mortgage growth anticipated to slow and could offset anticipated net interest margin growth
-Commonwealth Bank the least preferred major with brokers

By Danielle Austin

With the banking sector declining -15% in the weeks following an increase to the cash rate by the Reserve Bank in early June, economists have commented that the market has been quick to price in the impact of further rate hikes.

While the market had initially been positive on the impact of a rate rising cycle on banking net interest margins, predictions for a rapid, aggressive rate rising cycle has seen sentiment quickly decline amid concern of a cooling property market, and the flow on effect to mortgage growth.

While higher interest rates should bolster net interest margins, rapid successive rate hikes are likely to increase caution in the property market and lead to a notable slowing of mortgage growth rates.

For investors interested in the banking sector, weighing up potential net interest margin growth as rates rise against a likely slowing property market mortgage growth is something of a balancing act. Analysts note the sharp decline across the banking sector would suggest sentiment is currently focused on the downside, with the market seeming to have pivoted from viewing rate rises as positive for bank net interest margins, to viewing them as likely to weigh on growth in recent months.

Predicting rate rises and mortgage growth

While there is no guarantee as to how high, or how quickly, the Reserve Bank will lift its cash rate, the market does largely seem to agree that a series of rapid and aggressive rate hikes are ahead.

Analysts from Jarden note that borrowing capacity has already declined -10% in the current inflationary environment, and with banks slowly increasing expense assumptions to account for further inflation anticipated over the coming year, borrowing capacity will likely fall further.

The broker also notes that consumers appear more concerned about the impact of rate rises on property prices, rather than on repayments, at this point, and that buyers are showing more caution with loan capacity, now utilising 80-85% of capacity compared to previous 90-95%.

Analysts from Morgan Stanley calculate that a 2.5% increase to the current cash rate could see the average variable mortgage rate increase to 5.5% from 3.0%, or an 80% increase to borrowers’ interest payments. The broker anticipates mortgage growth to slow to between 3.5-6.0%, but expects average loan growth across the majors of 1.2% across the next two years.

With mortgage growth historically slowing significantly against quick rising cash rates, brokers are also largely anticipating a more significant slowing of mortgage loan growth than experienced in previous rate hiking cycles.

Morgan Stanley also highlighted with mortgage rates starting from a lower base and cash rate hikes likely to be larger, a steeper growth decline is anticipated in the current climate, noting mortgage loan growth slowed -5% and -3.5% respectively during the 1999-2000 and the 2009-2010 successions of rate hikes.

Commonwealth Bank sits bottom of the table for brokers

While the brokers have differing opinions on their top pick for the sector, they almost unanimously name Commonwealth Bank ((CBA)) as the least preferred stock across the majors. Citi highlighted that CBA continues to trade at a premium to peers at the moment, but the shift in consumer sentiment could mean a decline back closer to peers.

With CBA having 72% of its loan book tied to mortgages, the Citi analysts note improved performance from other banks is the biggest risk to the biggest bank’s valuation decline, and they do expect the other majors will be able to deliver better core profit growth in FY23 than CBA. Citi prefers both ANZ Bank ((ANZ)) and Westpac ((WBC)).

Jarden notes competition remains intense among the majors, and these banks are defending their market share with competitive pricing. It expects intense competition for mortgagees will largely offset rate rise driven net interest margin improvement. National Bank ((NAB)) is Jarden’s top pick, but it places ANZ as its least preferred, noting the bank continues to struggle for broker business and will need to improve processes to regain trust.

JP Morgan also listed NAB as its preferred sector pick, and the analysts from Morgan Stanley also have a preference for NAB. Both named CBA as their least preferred pick across the majors.  

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