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Pressure on bank earnings mounts as property stalls
The big banks are likely to face more difficult times ahead, with their earnings threatened by the slowing property market and higher interest rates and some home borrowers potentially defaulting on their home loans. The Commonwealth Bank recently reported a narrowing of its interest rate margins, a trend which could extend to the other big banks as funding costs rise, some analysts say.
The nation’s biggest bank last week posted an 11 per cent rise in cash profit to $9.6 billion in 2021-22. The increase in profits came despite a steep fall of 18 basis points in net interest margins (NIMs) to 1.9 per cent. Analysts expect this margin contraction continue to narrow as funding costs rise and also the number of non-performing loans as some homeowners default on mortgage repayments.
Morgans is the most downbeat on the Commonwealth Bank, advising investors to sell with a $77 price target on the stock. According to Morgans higher interest rates will increase the risk of asset quality deterioration and higher bond yields will place upward pressure on the banks’ cost of funding. Morgans also expects bank dividend yields to become less attractive relative to rising risk-free rates, which will undermine demand for bank shares and therefore their prices.
The most pessimistic of brokers is Morgan Stanley. It recently slashed price targets for all four of the big banks. It cut the Commonwealth Bank’s share price target to $79.00 from $91.00, ANZ’s valuation was cut to $24.30 from $28.90, National Australia Bank’s to $26.60 from $31.80 and Westpac’s to $22.30 from $25.70.
“We believe the probability of recession in Australia and New Zealand is rising,” said Morgan Stanley banking analyst Richard Wiles. “In the near term, higher interest rates support the outlook for margins and earnings, but we have lowered our major bank fiscal 2024 earnings per share estimates around 7.5 per cent on average to reflect weaker loan growth and higher impairment charges.”
Competition to intensify
UBS too sees more difficult times ahead for the big banks. According to UBS banking analysts, the big banks have around $350 billion of fixed rate mortgages requiring refinancing over the next two years, which is around 17.5 per cent of the total outstanding mortgage lending balance for the system. The Commonwealth Bank alone has reported it has around $140 billion of its fixed rate book maturing to June 2024.
“In a higher rate environment, borrowing capacity could be a challenge, which is something likely to impact on overall new business volumes and sector growth,” said a UBS research note. “This competition could impact NIMs, with price likely to be increasingly the weapon of choice to defend market share.”
Along with increased competition, UBS says higher funding costs from term deposits and wholesale funding will put further pressure on margins for all the big banks. “However, we think the majors and, in particular, the more retail focused Commonwealth Bank of Australia and Westpac can capture a larger percentage of the interest rate increases. We think this is possible given their funding mix and expectations of moderating lending growth,” UBS said.
NIMS contracting to historical low levels
According to data from the Reserve Bank of Australia, the NIMs of the big banks fell below 2 per cent for the first time ever this year, as the chart from the RBA shows below. Any ongoing contraction will put pressure on the big banks’ ability to generate profits and maintain high dividend payouts.
The Reserve Bank of Australia (RBA) has raised interest rates several times this year could keep on raising official rates towards 3 per cent by the year’s end. With inflation well above the RBA’s target inflation bank of 2 per cent to 3 per cent, some economists predict the RBA will raise interest rates by another 50 basis points at its September meeting, following rate rises of the same size in June, July and August, which is expected to slow down economic activity in Australia.
