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Bank results: the winners and losers

Morningstar analyst Nathan Zaia explains how the banks did and what the future holds.


James Gruber: Nathan, thanks for being here.

Nathan Zaia: Pleasure to be here.

Gruber: How would you characterize the Big Four banks' recent results?

Zaia: I think they were quite strong overall. I mean, the headwind that we knew was coming was on margins, but there was a lot of other positives. Most of them still getting low credit growth. Operating expenses are a bit of a headwind. A lot of the expense base is wages. So, banks, like every part of the economy, are feeling that pressure, despite branch closures and reducing the headcount where they can. But overall, balance sheets were sound. They're in strong capital positions. We saw dividends grow across the board. So, I think overall, the results were quite solid. The one thing, I guess, first half very strong and then earnings coming back in the second half, the trajectory was down in the second half. I think that's what probably overshadowed the result as a whole. The profit numbers were quite large, ROEs above 10%. So, I think overall, we thought they were decent results.

Gruber: Let's break down the margin issue. In terms of home loan competition seems to be part of that. Give us an overview of what's happening in the home loan market.

Zaia: Yeah. So, I think a couple of things at play. First one, we've got low credit growth. So, all the banks are fighting over a smaller pool of new lending. So, they're competing pretty aggressively for that. The second thing is refinance activity is much higher than it usually is. In Australia, 25% to 30% of loans, or maybe even lower for some banks, would typically be fixed loans. But during the last few years we saw 40%-plus of their loan books get fixed. There's a lot of people potentially looking to switch, especially when your rate goes from 2% to 6%. So, there's a lot of competition among the banks to get those borrowers as they move from fixed to variable. A lot of banks, customer picks up the phone and it's as easy as that and they're just giving them a sweet deal. So, there's a lot of pressure to retain those customers because it is cheaper to retain them than to go win a new borrower.

So, while that is happening as well, we've got some other banks, like ANZ is a bit of a standout here. They've been losing market share, and during this period, they don't have as much deposits coming from the households. So, it's more institutional and commercial business. So, they're not feeling the squeeze there as much. So, they've used that tailwind to chase after some home loan market share that they've lost in recent years. So, there's those dynamics not allowing a repricing that you would expect to take place over time as well.

Gruber: CBA has held back from that a little.

Zaia: Yeah, I think they've been the first to – they've tried to pull back a couple of times. They pulled cashbacks, they lifted rates, they got back in a little bit. But I think they are showing some discipline here. They do have a large loan book, so it's in their best interest to try and protect the industry profitability really. I think one thing they have that – well, some of them, others have to a lesser extent, is just the strength of their actual franchise. Where they've pulled back is in the broker channel. So, the flow through their own channels is still quite strong and that does cost them less as well. So, they're keeping more of the higher-margin, potentially sticky customers as well. Look, overall, there's a lot of flow goes through brokers. So, at some point, they might have to re-enter and be a little bit more competitive on price, but I think they're banking on the market can't keep pricing the way it is and things will ultimately change. They will just wait till it does.

Gruber: The other issue with margins is deposit competition. That seems to be heating up quite a bit.

Zaia: Yeah, I think it heated up a lot and has come off a little bit, but yeah, still very, very competitive. And I think there's again a couple of things at play. The first thing is the banks, the term funding facility that they got from the RBA, they have to repay that. So, there's a little bit of pressure to increase deposits a little bit more. We've got customer switching from transaction accounts to term deposits. So, in the last few years, if you were not getting anything on a term deposit or you're getting a little real lousy rate, there was no point locking up your money. So, now, we are seeing that money go back into term deposits. And it's hard to know exactly how much, but at the start of the rate tightening cycle, the banks were not passing on the rate increases as quickly on some of their saving products, a little bit of political noise around that. So, I think that might be at play a little bit as well. Like, let's just make sure we look after our savers and avoid more pressure coming down the track. So, they might be part of that, but I think competition is ultimately what's driven the pressure there.

Gruber: Let's go to the positives. Bad debts seem extraordinarily low still, healthy capital levels, dividends are still flying through. Is that a fair summary?

Zaia: Yeah, I think so, definitely. We've seen a little bit of a pickup in arrears, but even those arrears, those borrowers have equity buffers, they have savings buffers. So, as a whole, I think the loan books are looking like they're going to perform pretty well. The banks are sitting on surplus capital positions. So, even if there is more softness in earnings than we expect, those dividends do look pretty maintainable at the current levels even if earnings are a bit softer over the next 12 months.

Gruber: What's your outlook for the next 12 or so months?

Zaia: Yeah, I think one of the key areas is what will happen with competition on pricing both sides of the balance sheet. It's hard to know exactly when things might normalize. But we think maybe in the back end of the next financial year, you should see some of that competition for deposits and loans ease. So, I'd expect the banks to be able to manage their margins and improve them a bit from the troughs we're seeing. I think low credit growth is probably to be expected. And I'm not expecting any huge pickup in bad debts. But like I said, the household balance sheets, business balance sheets are pretty solid if you look versus historical levels. So, unless we have a material rise in unemployment, I think that's what would really alter the outlook. So, yeah, I think that's probably the key variable to the next 12 to 24 months.

Gruber: And what are your top picks amongst the banks?

Zaia: Westpac is on our best ideas list. We think it's the cheapest. It's on a forward P/E of around 11, dividend yield above 6.5%. We think it's got the same sort of competitive advantages as its peers. But one area where it's lacked is on the cost control front. And there still is a decent amount of investment that needs to be made to simplify its technologies, which is where they can get a lot more efficiencies out of the bank. So, we're assuming they can lower their cost to income ratio over the next three years. So, it will take time for these benefits to come to fruition. So, I think the market is a bit hesitant to give them the benefit of doubt on that front. But we just think it's a large bank. It's got cost of fund advantages. So, eventually, we think they should be able to get there. And when they do actually realize those benefits, I think there should be a re-rate of the share price. And I guess another positive sign is the momentum we're seeing in their home and business lending again, which is something that was lacking previously.

Gruber: Thanks for your time, Nathan.

Zaia: Thanks, James.



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