Australia’s major banks look set to boost earnings over the next few quarters as they benefit from a robust turnaround in the economy, but they will have to come to grips with growing cost pressures.
Cash earnings for three of the four major banks reporting half-year results in the past two weeks – ANZ, NAB and Westpac – totalled $9.7 billion, nearly unchanged from a year ago, despite fading margins.
Top lender Commonwealth Bank on Thursday posted cash earnings of $2.4 billion in the three months to March 31, steady from the first two quarters of its fiscal year.
The outlook seems far more encouraging after the Reserve Bank this month lifted its cash rate for the first time since 2010.
The 25 basis point increase kick-started a likely series of hikes that could see the benchmark rate hit 2 per cent by the end of the year.
Morningstar banking analyst Nathan Zaia said the steepness of the expected rate increases needed to get on top of inflation is what will benefit the Big Four the most.
“As the cash rate rises and the banks lift lending rates, their funding costs shouldn’t rise by as much and net interest margin expansion should come through,” he said.
Falling net interest margins (NIMs) – which reflect the difference between what a bank charges versus the cost of its funds – has been a common theme for bank earnings over the past year, largely brought on by a stiff fight for market share in home loans.
In the six months to March 31, ANZ’s NIM contracted five basis points to 1.58 per cent while NAB recorded a margin of 1.63 per cent, a decline of 11 basis points from a year ago. Westpac’s net interest margins slid 22 basis points to 1.85 per cent.
Much of that squeeze is expected to ease in the coming year as interest rates rise, providing more wriggle room to individual lenders and also boosting earnings and revenues.
A recent report by UBS banking analyst John Storey flagged that with every 25 basis point increase in interest rates, NIMs could expand by one to two basis points.
“We believe the market is underestimating the potential impact on bank earnings to a gradual rise in interest rates,” he said, estimating that the major banks could potentially add a combined $5 billion to revenue and lift NIMs by 25 basis points over the next three years.
While rate rises will address the NIM problem, no one is expecting the pressure to ease in the mortgage market, even as prices soften amid moderating property demand.
Industry executives are betting on high levels of refinancing activity over the next 12 months as scores of customers finish their fixed-price mortgages and roll over to higher-cost variable loans. All the major banks will try to secure a piece of this business.
“We expect asset price competition in the home loan market to remain intense and it may intensify further in a rapidly rising rate environment,” ANZ chief financial officer Farhan Faruqui told an investor briefing last week.
The other issue the big banks are grappling with is rising inflation, which is showing up on their cost base in the form of more staff to improve processing times, pay hikes and investment in technology.
Both ANZ and NAB have walked away from their target of reducing absolute costs, saying emerging inflationary pressures and the need to make investments to support growth have made the plan untenable.
Westpac, which has a cost base outpacing its peers, plans to stay the course in order to become more competitive. It reaffirmed a plan to cut costs to $8 billion a year by fiscal 2024.
KPMG Australia says major banks have struggled to structurally reduce costs in recent years.
“Inflation has driven up ‘run-the-bank’ costs, further growth and transformation costs have been added, and meanwhile some cost reductions from efficiency programs have been realised,” said Hessel Verbeek, its banking strategy lead.
“Unfortunately this means that the majors are not on a path of significant sustainable cost improvements.”