Australian Banks: Future Not Bright

Feature Stories | May 17 2023

Despite a bank result season highlighting record earnings, margins disappointed, competition is even stiffer than feared, and brokers are hunkering down.

-Banks reporting season reveals record earnings, weaker than expected margins
-Competition for mortgages more intense than expected
-Earnings downgrades follow
-Relative value improves nonetheless

By Greg Peel

The world has changed, highlights Credit Suisse (and not just for Credit Suisse). Online bank accounts mean transferring money to chase higher rates is at a click of a button. Payments are now instantaneous. Social media means money flows can move very quickly especially when confidence levels change, which begs the question: why pay a premium for a bank that is exposed to these phenomena?

Previously, bank deposits were seen as a source of lower-rate funding for banks (as opposed to issuing debt) and as “sticky”. The former is controlled by just how low banks are prepared to risk keeping their deposit rates below their lending rates as interest rates rise, and that latter harks back to the days when households chose one bank and stuck with it, and a mortgage application would require a meeting with the local bank manager.

For small businesses it required taking the local bank manager to lunch.

In more recent times, as Australians have moaned and groaned about banks not passing on rate cuts in full to mortgage rates, while passing on rate hikes in full immediately, depositors have been the forgotten Australians. If deposit rates are either cut swiftly in the first instance or raised very slowly in the latter, only a bunch of retirees get upset, and no one much pays much attention.

But as Credit Suisse points out, times have changed. Even retirees now know how to use a computer.

After decades in which loan rates, and particularly mortgage rates, have been as good as the sole focus for Australian banks and bank-watchers, suddenly the tables have turned. Not that loan rates are no longer important – they still are – but suddenly it’s all about deposit rates.

It was deposit outflows that killed Silicon Valley Bank, and deposits which led to surprise and disappointment during the recent run of Australian bank earnings reports and updates.

What Had Been Expected

Bank analysts had been well-prepared for a step-up in competition for deposits among Australian banks, as RBA rate hikes near a peak, but not prepared for just what extent said competition impacted on bank net interest margins (NIM), or the difference between borrowing (deposits and debt issuance) and lending (mortgage and other loan) rates.

As outlined in Australian Banks: Clouds On The Horizon ( https://www.fnarena.com/index.php/2023/04/14/australian-banks-clouds-on-the-horizon/ ) published last month, bank analysts were warning that while the first half of FY23 (which varies for different banks) would be a cracker, thanks to the NIM opportunity provided by RBA rate hikes, bad debts remaining sufficiently low, and cuts to operating costs, it would prove a peak. From thereon, it would be all downhill.

Competition in both new loans and deposit rates would lead to falling NIMs, rising mortgage arrears (particularly given the mortgage “cliff”), lower loan demand due to rate hikes and subsequently lower earnings.

Well, they weren’t too far off, other than in their timing.