Australian Banks: Tailwinds Now, Headwinds Next

Feature Stories | Nov 23 2022

Six months ago bank analysts knew exactly what would transpire over the following six months. While the next six should also be positive, it’s a different story thereafter.

-Bank results featured rising margins and rising costs
-Margin tailwinds expected into FY23
-Headwinds to blow strongly thereafter
-Wage inflation a pervading factor

By Greg Peel

Ahead of the last bank reporting season, six months ago, when ANZ Bank ((ANZ)), National Australia Bank ((NAB)) and Westpac ((WBC)) reported interim earnings and Commonwealth Bank ((CBA)) provided a quarterly update, a completely blindsided RBA implemented its first rate rise post-covid, right before the election, due to a surprise jump in inflation.

At least, the RBA was surprised – nobody else was. Economists had been warning for months.

The hike was a great relief to the banks, which had wallowed through two years of a near-zero cash rate, forcing historically low mortgage rates amidst stiff competition and hence minimal net interest margins (spread between borrowing and lending rate). NIMs provide some 80% of bank revenues.

Now there was light at the end of the tunnel. The first RBA rate hike was not going to be the last, and NIM expansion was back on the agenda. If the banks lifted their mortgage and other loan rates really quickly (which they did), and their deposit rates really, really slowly (which they did), they could squeeze the most out of it.

Happy days were here again. The tailwinds were a-blowing. Bank analysts saw earnings growth ahead, and a purple patch for the banks, at least for a period. Not forever though.

There were also headwinds. NIM expansion is all well and good as long as you have the loan demand to provide the revenue boost. Falling demand works the other way, and given the headwinds of higher interest rates on loan demand, and rising inflation and a rising cost of living on households, that purple patch was seen as having a limited expiry date.

What’s more, rising rates implied an inevitable fall in house prices, and the risk of rising mortgage defaults amongst borrowers on too-high debt-to-income ratios.

Rising inflation also implied rising costs for the banks, particularly in wage costs. Between them, the banks employ some 40,000 workers. Bank costs were already on the rise, from Royal Commission-driven remediation and compliance costs, to technical upgrade costs required to head off the rise and rise of digital fintechs.

The general feeling among bank analysts was enjoy it while you can, as it’s not going to last.

Well, in the six months hence the ASX200 banks sector total return (including dividends) is about where it was six months ago. However, all global equity markets tumbled through June, as the Fed led the rate hike spree. Since mid-June, that index is up over 24%.

That was the set-up going into this month’s bank reporting season.

And so it came to pass

The banks did all enjoy increased NIMs over the ensuing period, milking it for all it was worth by immediately raising loan rates with every RBA hike – totalling 275 basis points to date – while ignoring depositors until only recently.

It was a case of who would blink first, but ultimately competition forced deposit rate increases, but with much healthier margins to loan rates than was the case when the RBA cash rate was 0.10%. The banks all reported strong NIM growth over the period (including an update from Commonwealth Bank), but despite a bit of variation between them, this was largely as expected.

Importantly, NIM “exit rates” remained healthy. In other words, NIMs were still on the rise as the banks moved into their new financial year (or new quarter for CBA).

Bank analysts therefore see NIM tailwinds continuing into the first half of 2023. But the RBA will likely continue to raise rates into next year, house prices have begun to fall but are yet to really tank, Australia is expected to avoid actual recession but an economic slowdown is inevitable, and after a bit of a post-lockdown spree, consumers are expected to tighten the purse strings once Christmas is out of the way.

Loan demand, for both mortgage and business loans, is expected to contract, competition will remain fierce, and analysts believe the NIM party will come to an end by the second half of 2023, if not sooner.


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