Key points: 

  • Banks have benefited from rising interest rates, but margins and earnings appear to have peaked.
  • The second half is likely to be a bit weaker than the first half. But over time, we expect the market to be rational in setting prices for both deposits and mortgages and try to make a decent return for shareholders.
  • The outlook for bad debts is also weighing on bank shares. We expect to see a material rise over the next 12 months, but we don't think it'll be anywhere near as bad as we saw in the GFC.
  • Dividends could potentially grow a little bit in the second half even if earnings are weaker because first half payout ratios were at the lower end of their target ranges.

Read more on the Big Four Bank earnings here, and investing opportunities outside the major banks.

Transcript:


Nathan Zaia: Yeah, so the major bank results were actually quite solid. We had margins expanding, they had small loan growth still, bad debts remain very low, operating expenses are a challenge at the moment. We all know the pressures from inflation, and the banks – a large part of their costs are wages. So, that's obviously going up. But look, it was all managed pretty well. We saw pre-tax profit across most of the banks up around 15%. So, really solid results.

The trajectory in margins, I think, that is one thing that has concerned people and look, I guess, it does look like margins and earnings have peaked. So, what has been driving that margin expansion as the interest rates or cash rate went up, the spread between what the bank earns on what it's paying a borrower versus what it pays out on its funding. So, deposits that gap has widened. So, they have benefited. What we expected was it would take time, but that would get competed away. But it does look that upside won't be as material as we first thought and that is down to competition.

So, I think there's probably a couple of things driving that. The profitability is still there in mortgages. So, the banks are working really hard to retain their customers. And switching is quite elevated at the moment or could be because you have these fixed rate customers rolling off. Now, they're paying a lot more so that is a big increase and it incentivises you to go look for a better deal, especially if you're going to struggle to make your payments. So, the banks are discounting quite heavily on those mortgages and the deposits to keep as many as possible. It generally is cheaper to keep your customer than win a new customer. So, we think there is a few things that have added to that margin pressure. So, it does look like the second half will probably be a little bit weaker than the first half. But over time, we expect the market to be rational in setting prices for both deposits and mortgages and try to make a decent return for shareholders.

The other thing we think weighing on share prices at the moment is the outlook for bad debts and that really is uncertain. They have really large loan books, so the potential is that these numbers, become quite substantial over time and we really are starting from a real low point in terms of stress on the loan books, people behind in their loan repayments and also loans that are going bad. So, we think we will see a material rise probably over the next 12 months, but we don't think it'll be anywhere near as bad as we saw in the GFC or when we had to see the large increases in COVID provisions.

We thought the first half dividends were actually good. They were a little bit higher than we expected and looking forward we think they're sustainable and they could potentially grow a little bit in the second half even if earnings are weaker. And the reason we think that is because the payout ratios that paid in the first half, they're still at the lower end of their target ranges, and that's supported by strong capital positions across all the banks. Four major banks combined have 12 billion above their capital target ranges, so that provides a nice buffer to support dividends, support loan growth and if there is more loan losses than we expect that should be covered as well.