Australian banks face margin pressure amid low rates: Reporting season roundup |
Tweet | ![]() |
<p><strong>Emma Rapaport: </strong>Hello and welcome to Morningstar. I'm Emma Rapaport. Today joining us is Nathan Zaia. He is our banking analyst here at Morningstar.</p>
<p>Nathan, thank you very much for joining us.</p>
<p><strong>Nathan Zaia: </strong>Thanks for having me, Emma.</p>
<p><strong>Rapaport: </strong>Nathan, you covered both the major banks and the mid-sized banks, and a lot of the financial services sector. But for today, I'd really like to focus on the reporting season for the major banks. So, can you walk us through what you learned during reporting season? And some highlights and lowlights amongst our major financials?</p>
<p><strong>Zaia: </strong>Yeah, okay, sure. I think broadly, things are tracking as we're expecting for three of the majors certainly a quarterly update, don't forget, and for CBA their full year result.</p>
<p>So, I think if we start with credit growth, it's really had a bit of a shot in the arm from low cash rates and government support packages. But it's hard to imagine that just continues on, especially with the strong house prices that we've had. I think at some point, you're going to see first-time buyers, which have been driving a lot of demand being priced out of the market. So, yeah, I think, what we've seen in the last 12 months or so might have a little bit more to run. But I think credit growth probably slows down to that low-single digit level over the next couple of years.</p>
<p>Net interest margins has been a really interesting one. And we've kind of been waiting for the pressure to come through in the results, given how low cash rates are. Ordinarily, you'd see the bank's margins and earnings come under pressure. But, strangely enough, due to COVID, rising customer deposits have made – the banks didn't have to price as aggressively. And they've had the term funding facility. So, that's really helped. But we are starting to see that pressure come through now. And I think commentary from the banks does support what we've been saying that it's probably going to get worse over the next couple of years. We've got a lot of older loans, which for us – would made higher margin being repriced onto newer loans. And we've also got a lot of demand for fixed rate, given how low rates are at the moment. So, those things are going to be headwinds for the banks.</p>
<p>NIM, we're already seeing it and I think it'll probably get a little bit worse. I don't want to disregard the potential for rising bad debts as we come out of lockdowns and government support, which has come through again, is pulled. But the banks, they've really did take conservative – or they look very conservative now provisions last year for loan losses. I think that probably is one of the highlights just how strong the banks loan books are, how they are holding up where arrears are very low. The banks is very well-capitalised, very well provisioned. So, they're in a really good position.</p>
<p><strong>Rapaport: </strong>Leading into reporting season you predicted some pretty big dividends and payouts amongst our major banks. Did those payouts eventuate? How did they eventuate? And do you expect more to be coming?</p>
<p><strong>Zaia: </strong>Yeah, broadly, yes. I think CBA's payout ratio was a little bit lower than what we had. We kind of figured – when you've got such a large capital buffer, and your earnings are so strong, you're not going to pay out the top end of your payout ratio at that time, then will you ever but that was slightly lower than what we thought but not material.</p>
<p>In terms of the buybacks, yeah, that's pretty much what we expected to Commonwealth Bank. The 6 billion off market buyback (indiscernible) the on-market route. We did think the other two would probably do part of their capital management through off market. But yeah, that hasn't eventuated. But yeah, we don't think the banks have done either. We think they're still holding capital well above regulatory requirements. So there probably will be a little bit more over time. I think it's more of a timing thing like we still think Westpac will make an off-market buyback, we forecast 4.5 billion and probably get announcement released the result in early November. The shareholders probably have to wait a little bit longer for that one.</p>
<p><strong>Rapaport: </strong>Shareholders love getting dividends and they love buybacks, because that means more cash in their pockets. But from an equity analyst perspective, do you think this was the best use of their capital? Is there a reason that they decided not to invest in their own businesses and pay the money out?</p>
<p><strong>Zaia: </strong>Yeah, that's a good question. That's always the decision that each needs to make. But I think if you look at their opportunities to grow their loan books, so if they had business lending or home loans like they're doing as much as they can on that front, and the banks have just gone through a process of divesting everything that's non-core to those banking operations. So, really, they would be looking for opportunities where they can add things that help those businesses, they're all pretty small things. So, it's hard to find a large investment opportunity that would move the needle and actually support where they have their competitive advantage. So, I think that's why the banks are probably turning to returning at least some of this excess capital to shareholders. I think it is the right thing to do.</p>
<p><strong>Rapaport: </strong>This story of the banks having a really good half - is that across the entire banking sector? Are the small and medium-sized banks experiencing that same rebound?</p>
<p><strong>Zaia: </strong>Yeah, it's really across the whole industry. And for the smaller and mid-sized banks, I think they're actually benefiting a little bit more than the majors. If you think about their funding costs, they don't typically have as much cheaper wholesale funding, they rely more on securitization markets. And at the moment, they're able to get those cheap customer deposits that the majors rely so heavily on at similar sort of prices as well. So, they don't have that disadvantage. And I also think the majors kind of getting bogged down in refinance applications. Whereas if you're a smaller lender with a smaller loan book, it takes more before your loan approval processes blow out and it becomes slower. And we're seeing it in their loan growth like Bendigo grew its loan book or home loan book 15%, and the market grew 5%. So, I know they've really enjoyed this period as well.</p>
<p><strong>Rapaport: </strong>So, I want to focus quickly on the CBA result. The only major bank, as you mentioned before, to have a major result, as opposed to just a quarterly update. We saw a 20% increase in profits, what was driving those profit figures for the half?</p>
<p><strong>Zaia: </strong>Yeah, for the full year, the big swing factor was last year the bank was raising loan impairment provisions for the losses that were going to come through or they thought might come through. And they're obviously – not having to do that, but they're also releasing some of those provisions. So, it's really flattering the growth rate that we're seeing in this period.</p>
<p>If you look at the result before those loan, impairment expenses, bank profit was up slightly on last year. And I think the second half was up about 1% on the first half. So, it's really like quite anemic growth at the underlying rate. That's CBA delivering strong loan growth. But as we mentioned earlier, some pressure on net interest margins, and the bank is continuing to invest for the future. And I think you don't get that strong loan growth, and make sure that it continues to come in and hold your market leader position without that ongoing investment. So, there is a couple of moving parts, both behind the underlying, but it's really those loan impairment expenses that have driven a large swing.</p>
<p><strong>Rapaport: </strong>As you highlighted, CBA, in particular, have seen a real price increase. They've gone from about $57 during the lows of March 2020 to around $108 today – a really big increase. In your opinion, are shares currently trading under or at an overvalued level?</p>
<p><strong>Zaia: </strong>No, we think they are a little bit overvalued at the moment. If you go back to March 2020 everyone was trying to guess what sort of credit stress the banks would see over the next 12, 24 months and they are being priced for, I'd say a pretty dire situation, but then also being priced as if that situation would never end. And then if you look at current levels now and CBA is on a P/E of 19, a dividend yield under 4%. And that yield might sound appealing and I think that's probably what is – you're seeing a lot of retail holders happy to keep buying CBA. But let's not forget, earnings are vulnerable to economic weakness. And it's, I guess, a little bit surprising that, the reminder that 2020 was has pretty much been being brushed off by the market. So, already we're seeing CBA make highs. So, yeah, I think it is overvalued. The other banks trading around fair value or Westpac slightly below fair value I think they are better options at the moment.</p>
<p><strong>Rapaport: </strong>In terms of good ideas in the banking and the financial services sector - you spoke a little bit before about how Westpac is undervalued. But are there any names that you would highlight in your coverage to investors– even outside of the banks?</p>
<p><strong>Zaia: </strong>Yeah, the biggest fair value change we made have been post reporting season. And that was two smaller companies I cover, so that's Steadfast and Austbrokers. They're both narrow moat rated names. And they really didn't missed a beat during COVID. There was very little impact on their businesses in what was a very volatile and uncertain period. And that kind of got us rethinking about the resiliency of these names. So, for those that don't know, they are insurance brokers, and they make a commission based on the insurance premiums that their brokers derive, so they take no underwriting risk, so they're not on the hook for claims at all.</p>
<p>So, we concluded that, yes, there would be some impact on premiums if businesses fold in really tough economic periods, but it's probably less severe than the majority of businesses we cover. Insurance is typically one of the last expenses that people trim, the consequences of not having adequate cover can be significant. So, taking the view that earnings risk is below average, because these businesses have quite resilient business models, and because they are growing strongly by reducing our discount rate, our fair values went up by around 30%. So, we see both of those names undervalued at the moment.</p>
<p>Just a quick, why do we like these businesses, first of all, we think there is customer switching costs, brokers typically have no incentive to leave their network. And in many cases, the network owns stakes in those brokers anyway. And customers generally don't leave their broker. And we think revenues are prime to continue to grow. We've got insurance premiums rising, they're not making good returns at the moment, they need to keep putting up premiums, brokers are taking more and more share of the market. And businesses and even individuals are finding the benefits of using a broker which has expertise in the space and can shop around across different insurers. It's pretty much like you're going to a mortgage broker. And these are very capital light businesses, they're generating strong free cash flow, and that's supporting both dividends and ongoing growth in their businesses.</p>
<p><strong>Rapaport: </strong>Great. Thanks for those ideas. Just to close out, we've been asking all the analysts to spend the month listening through hours and hours of earnings calls and reading through presentations and PDFs and everything that comes with it. If there was anything that they can share with our viewers that they learned during an earnings call, maybe they were listening to a management team that maybe was surprising, or something that you picked up during these sessions that you could share?</p>
<p><strong>Zaia: </strong>Yeah, it's probably not that interesting or surprising. But I would say, in general, like the contrast between this year's call and last year is just management did not appear as concerned at all about lockdowns that we're in at the moment. I believe banks were actually releasing reserves and returning capital during these lockdowns. And I think we've seen how effective the vaccine is, how effective government support has been. And while there is still a lot of uncertainty, I think there is a lot more confidence this time around than there was 12 months ago. And I think the one thing that was caught out in a few places was just timing on international borders opening back up, that's one area where there still is a lot of caution.</p>

11/08/2022 Senior equity analyst Brian Han talks about Telstra's highlights this reporting season.

11/08/2022 Equity analyst Nathan Zaia talks through CBA's highlights this reporting season.

05/08/2022 Morningstar believes travel will be back in 2024.

29/07/2022 The latest update management told investors what they wanted to hear—cost cutting, lowering credit risk and a commitment to reduce cash burn.

27/07/2022 Momentum for the consumer discretionary sector is going backwards and spells trouble for earnings.

21/07/2022 Suncorp shareholders are selling at a premium while ANZ gets an easy way to scale up home and SME lending.

07/07/2022 Bond exposure growing as the portfolio prepares to get defensive.

04/07/2022 Rebalancing, tax-loss selling, and buying on the dip are among the productive moves to consider.

04/07/2022 Growth jitters and the possiblity of reduced iron ore demand in China have swiped the heavyweight banking and resources sectors.

01/07/2022 Morningstar equity analyst Jon Mills explains royalty rate hikes and how the changes impact Australian miners.

29/06/2022 Firetrail's head of investment strategy talks through his global equity picks in the sustainable space.

28/06/2022 While the benefits of the current model are modest, a demerger won't deliver shareholders an automatic win, says Morningstar equity analyst Nathan Zaia.

24/06/2022 "I think over the next sort of, three, six, nine months, we're going to see some pretty good opportunities emerge, and I think investors who are well prepared will be able to take advantage of that."

23/06/2022 Policy will continue to fuel short-term price movements but the long-term fundamentals for Australia's biggest export look shaky.

17/06/2022 The founder of Investors Mutual is cool on Australia's banking giants.

15/06/2022 Faster interest rate hikes from the Reserve Bank have markets worried about bad debts, says Morningstar banking analyst Nathan Zaia.

14/06/2022 Highly likely investors are on the cusp of an era of permanently higher rates that should favour "real-world companies", says Andrew Clifford, co-chief investment officer at Platinum Asset Management.

14/06/2022 Build cash and prepare for opportunistic nibbles at companies such as Aurizon, Wesfarmers and James Hardie, says Morningstar's head of equity research.

10/06/2022 We haven't seen the bottom of the bear market yet, says Morningstar's head of equity research.

01/06/2022 Earnings growth remains market leading for wide moat stocks like Alphabet, Meta Platforms and Amazon.

30/05/2022 Labor looks set to proceed incrementally and existing producers such as Whitehaven Coal could even benefit should more radical policy be proposed.

25/05/2022 The Nobel prize winner who cameo'd alongside Selena Gomez in Hollywood hit The Big Short discusses the latest developments in behavioural economics.

19/05/2022 Local investors were spooked after US retail giants Target and Walmart plummeted overnight as rising prices hit margins and inventory.

19/05/2022 On his recent visit to Australia, Morningstar's global chief investment officer Dan Kemp talks investing narratives, confronting the growing list of reasons to be concerned about markets and sustainable investing.

19/05/2022 Worries about inflation’s toll on earnings sparks Wednesday’s 4% plunge, but stocks are now far undervalued.

18/05/2022 One of the big themes of the year has been the value comeback. What is behind this resurgence after a pretty dismal period, and should your portfolio be tilting in its direction?

11/05/2022 Here's what investors who are worried about a recession should consider today.

11/05/2022 Morningstar analysts have identified TPG telecom as the most undervalued telecom stocks in the ASX 200 detailing multiple catalysts for earnings recovery and growth.

29/04/2022 Exclusive: Hermitage Capital Management CEO Bill Browder talks Putin, Russia, and the next six months for Ukraine

28/04/2022 Inflation, rising interest rates, geopolitical risks, and other things to keep your eye on.

27/04/2022 Morningstar's analyst talks about the Buffett's recent deals, what the stock is worth, and whether Berkshire will pay a dividend any time soon.

31/03/2022 Supply disruptions following Russia's invasion of Ukraine are forcing analysts to consider the possibility elevated prices persist.

30/03/2022 Rising interest rates, strong economic growth and cheaper valuations are driving banking stocks ahead of the broader market.

28/03/2022 Where are entertainment and streaming services headed?

24/03/2022 Problems in global supply chains are an opportunity for WiseTech as its logistics company customers move to replace old software.

23/03/2022 Markets focused on floods and bushfires are missing how insurers are cutting costs, doing more digitally and are looking down the barrel of a lift in investment income.

17/03/2022 Morningstar Investment Management's global CIO Dan Kemp explains why well-intentioned investors desperate for peace in Europe are making dangerous market calls

15/03/2022 Knowledge of the local market, strong branding and a growing subscription service should see the undervalued retailer retain market share in the rapidly growing online sales category, says Roy Van Keulen.

08/03/2022 Higher inflation, rising interest rates and booming commodity markets are driving a major rotation away from the post-pandemic winners, says Tim Murphy, Morningstar director of manager selection.

03/03/2022 Regulators are likely to be less lenient now the buy-now-pay-later sector is part of the fabric of Australian payments.

23/02/2022 Strong commodity prices, cheap valuations and a head start on interest rate hikes means emerging markets are set for strength, says Dr. Joseph Lai of Ox Capital.

23/02/2022 A belligerent speech from a president signalled the start of the latest phase of Russian agression last night, causing markets to wobble and investors to wonder.

15/02/2022 In an extended interview, Morningstar's Peter Warnes discusses the bear market in US technology stocks, interest rates and growth and his approach to investing outside the US and Australia.

13/02/2022 Morningstar equity analyst Shaun Ler explains why he see valuation upside high for MFG even as shares lose steam.

31/01/2022 The Chinese lunar year is almost over, and what a ride it's been. Morningstar speaks to JPMorgan Asset Management strategist Mike Bell about what's ahead.

23/01/2022 Christine Benz discusses how investors should handle the turmoil, whatever the life stage.

18/01/2022 Empty shelves will negatively impact supermarkets in the second half of fiscal 2022 but the impact on long-term earnings is minimal, says Morningstar analyst Johannes Faul.

17/01/2022 Bank earnings, house prices and China risk: Our experts and analysts discuss what they've got their eyes on in 2022.

24/12/2021 Our experts and analysts weigh in on what mattered for investors last year.

21/12/2021 New products, lower fees and a portfolio of undervalued stocks set to help the fund manager right the ship.

10/12/2021 And how does it match up against gold?

10/12/2021 Australian miners to be among the last standing as coal use fades.

08/12/2021 Rebalancing your portfolio is one of those beneficial habits that’s easy to let slide. But year-end is an ideal time to check how your portfolio is tracking against your target asset allocation.

03/12/2021 The gold-rated fund manager shares three ideas with long-term potential.

01/12/2021 Long-term investor sees opportunities where businesses are moving towards a zero-carbon future faster than governments.

30/11/2021 To understand your fund, get to know its underlying index.

29/11/2021 These companies are set to profit from the move to clean energy, says Lazard.

24/11/2021 The results of the COP26 climate summit suggest coal demand is likely to persist for longer than expected.

17/11/2021 And how investors can protect their portfolios.

08/11/2021 Morningstar thinks these moaty companies will remain resilient in the face of inflation and ongoing supply chain challenges.

05/11/2021 Morningstar maintains fair value despite a fall in margins and slower progress on cost reductions.

19/10/2021 These new US-listed exchange-traded funds will invest in bitcoin futures, not bitcoin itself.

15/10/2021 The ESG outperformance narrative is flawed, new research shows.

06/10/2021 Investors may need to hold more growth assets over the coming years, says Morningstar's Jody Fitzgerald.

01/10/2021 And how G8 Education and Link Administration are positioned for long-term success.

30/09/2021 What Reporting Season August 2021 told investors about the health of the financials sector.

28/09/2021 a2 milk is an opportunity to be greedy when others are fearful.

23/09/2021 Covid's winners and losers are returning to their prior trajectories.

21/09/2021 Sequence-of-returns risk matters for both retirees and savers. Here's why.

20/09/2021 Analysts expect the sector to recover to pre-Covid trading levels once borders reopen.

15/09/2021 Rising customer deposits and access to cheap funding helped Australia's banks stave off net interest margin pressure, but analysts see warning signs.

14/09/2021 Morningstar's Hortense Bioy on how to spot greenwashing and how to avoid it.

13/09/2021 Utilities and infrastructure names battle the impact of covid as private equity and pension funds circle.

10/09/2021 Hydrocarbons poised for a comeback.

09/09/2021 Providers have lifted prices after years of a debilitating chase for subscribers at all costs , says Morningstar's Brian Han.

08/09/2021 What shorting ETFs means for long-term investors.

07/09/2021 Morningstar senior analyst Grant Slade says Brambles secular growth trend is intact despite nearterm headwinds. He discusses results from the building and construction materials sector.

03/09/2021 Miners bask in the glow of iron ore prices while bargains remain in coal.

23/08/2021 Post-merger Woodside would be well positioned to deliver on the value we've seen for a long time, say Morningstar analysts.

16/08/2021 But the sector lacks uniformity, says Morningstar's Christopher Franz.

11/08/2021 Higher wholesale electricity prices bode well for AGL, according to Morningstar senior equities analyst Adrian Atkins.

11/08/2021 Morningstar FundInvestor editor Russ Kinnel describes some direct and indirect hedges for inflation protection.

10/08/2021 Copper and iron ore have benefited materially from China’s stimulus and the developed world recovery. But Morningstar analyst Mat Hodge see these benefit as transitory.

05/08/2021 We believe the transaction has a high chance of succeeding.

03/08/2021 The industry still has significant growth potential.

03/08/2021 Is one of the biggest sponsors of the Olympics positioned for an all-electric future?

23/07/2021 Morningstar's Lex Hall talks micro-cap stock picks with Carlos Gil, chief investment officer at Microequities Asset Management.

22/07/2021 Mornngstar's Lex Hall catches up with Carlos Gil, chief investment officer at Microequities Asset Management.

21/07/2021 The head of Australian small and mid-cap stocks at First Sentier Investors has her eye on ARB, Breville and IDP Education.

20/07/2021 The strong performances of global stock markets in 2020–21 are unlikely to be repeated in the coming year says Morningstar's Peter Warnes.

12/07/2021 Morningstar equity analysts warn that equities remain overvalued despite Australia's strong economic recovery.

08/07/2021 Private equity is an exciting area for investors, with lots of hotly-tipped stocks. But there are risks to be aware of, says Pitchbook analyst Dylan Cox.

08/07/2021 Warryn Robertson is looking at French infrastructure, retail pharmacy and tax services.

06/07/2021 Australia's largest banks have excess capital because they cut dividends, were more conservative on lending, divested assets and raised equity last year. Morningstar's Nathan Zaia thinks most of it should be returned to shareholders.

02/07/2021 PEXA burst onto the ASX this week in the biggest float since 2019. Morningstar's Gareth James gives his take on the company's future growth prospects.

30/06/2021 Iron ore prices have been on a tear, boosting the profits of Australia's top miners. How did we get here and is the only way up? Lex Hall sits down with Morningstar's Mat Hodge.

28/06/2021 Morningstar has recently initiated coverage of a food delivery app and a consumer finance product.

24/06/2021 Meeting the deluge of demand is the biggest task for US companies, says Bell Asset Management's Ned Bell.

22/06/2021 Are there still opportunities in the biotech sector now the covid-19 vaccine roll out is underway? We ask International Biotechnology Trust manager Ailsa Craig

21/06/2021 Morningstar's director of Asia equity research is confident the e-commerce giant will bounce back.