Belt-tightening time for the big four
Stocks in bank enjoyed a stellar year in 2012, but the slowing economy and debt-shy consumers are threatening to take some wind out of the sector's sails.
To be sure, more profit records are likely to tumble as the big four rack ever bigger earnings, with the Commonwealth Bank next week tipped to hand down a $3.65 billion half-year profit.
But, according to analysts, it is likely to be a slower grind for the big banks as they look to shore up their bottom lines by paring back costs and flexing their market muscle.
After a 28 per cent surge in bank stocks in the last year, which has pushed the Commonwealth Bank's market value through $100 billion, there are also questions over whether the share price gains are justified by earnings.
The National Australia Bank this week surprised the market with better-than-expected December-quarter cash earnings of $1.45 billion, helped by lower charges for bad debts.
Investors expect the other majors handing down results this month, the Commonwealth and ANZ, will also post solid profit growth. Westpac no longer reports profits every quarter.
However, analysts stress it is not a return the boom days of credit growth. In the year to December, the lucrative market for owner-occupied housing loans grew at its slowest pace on record, at 4.1 per cent.
Despite sluggish credit growth, bank bottom lines are benefiting because investors' fears of rising bad debts caused by an end to the mining boom have failed to eventuate, at least for now.
The managing director at White Funds Management, Angus Gluskie, said the upcoming earnings season would be characterised by slower growth for banks, but also diminishing risks. "The prospect of a sharp rise in bad debts and a meltdown in unemployment is looking more remote," Gluskie said.
Jobs figures this week tended to support this view. While the labour market still looks fragile, the unemployment rate remained steady at 5.4 per cent, once again defying predictions it would rise.
Also bolstering bank profits have been the fall in funding costs in recent months.
The Reserve Bank governor, Glenn Stevens, this week pointed out bank access to funding had improved significantly, and borrowing conditions for large corporations were "very attractive".
With the big four also declining to pass on in full the 0.5 percentage points in interest rate cuts in October and December, analysts think the industry's margins from lending have probably widened.
NAB reported wider margins across is customer base during the December quarter, a likely reflection of its decision to not pass on interest rate cuts in full.
Bell Potter analyst T. S. Lim says all big four lenders have probably managed to sustain their profit margins in recent months, despite competition for deposits continuing to put upward pressure on costs.
"I think for the big four we will probably see stable margins coming through, as wholesale funding has improved in the last few months," Lim says.
None of this, however, points to a dramatic improvement in the banking industry, which shed significant numbers of staff last year. Instead, analysts are tipping solid, if not spectacular, results.
Macquarie Private Wealth this week predicted the coming reporting season for Australia's banks would be a "stay of execution ... for now," because investors' worst fears for a jump in bad debts were unlikely to be realised.
While the broker expects the Commonwealth's margins to benefit from its failure to pass on rate cuts in full, it also stressed growing concern about the risk of loan impairment after the mining investment boom peaks.
Gluskie describes the earnings outlook as reasonable, but cautions that much of the good news has already been factored into the rising share prices of banks. The Commonwealth, for instance, has seen its market capitalisation soar above $100 billion in the sharemarket rally of earlier this year, to a level that is more than 14 times annual earnings.
For all of the banks' market clout, some investors are questioning whether their likely earnings growth justifies such high prices.
A survey by Bank of America Merrill Lynch suggested this week many of the biggest fund managers have become more lukewarm towards the banks in the December quarter.
Close to 60 per cent of those surveyed said they were somewhat or very "underweight" on bank stocks, meaning the sector plays a relatively less important role in their portfolios.
Whether the professional money managers are right to be cautious over the sector's prospects will soon become clearer.
Frequently Asked Questions about this Article…
The article suggests caution. While the big four have delivered strong recent gains and are still posting solid profits, analysts expect slower earnings growth ahead and note much of the good news may already be priced in. A Bank of America Merrill Lynch survey also found around 60% of major fund managers were somewhat or very "underweight" bank stocks in the December quarter, signalling professional caution.
Analysts expect the upcoming reporting season to show solid but not spectacular results. Banks are benefiting from lower funding costs and fewer bad-debt fears for now, but credit growth is sluggish and risks such as loan impairment after the mining investment peak remain. Experts describe the outlook as reasonable with diminishing downside risks, rather than a return to boom-time credit growth.
The article notes Commonwealth Bank was tipped to post about a $3.65 billion half-year profit and that its market value had passed $100 billion. National Australia Bank (NAB) surprised the market with better-than-expected December-quarter cash earnings of $1.45 billion, helped by lower charges for bad debts.
Margins have likely widened because the big banks did not fully pass on the Reserve Bank's 0.5 percentage point rate cuts in October and December, and wholesale funding conditions improved. That helped profits, but analysts warn this benefit may be temporary and margins are expected to remain broadly stable rather than expand dramatically.
Falling funding costs boost bank profitability because banks can borrow more cheaply. The Reserve Bank governor noted bank access to funding had improved significantly, and analysts say improved wholesale funding helped sustain margins in recent months. For investors, lower funding costs can support near-term earnings, but other factors like credit growth and loan impairment risks still matter.
Key risks highlighted include slowing credit growth (owner-occupied housing loan growth was at a record low of 4.1% year‑on‑year), potential loan impairments if the mining investment boom peaks, and a fragile labour market. While bad‑debt fears have not materialised yet, analysts caution these remain areas to monitor.
Analysts in the article question whether share price gains are fully justified by earnings. While banks have seen strong share rallies—Commonwealth Bank's valuation rose above $100 billion, trading at more than 14 times annual earnings—experts note much of the good news may already be priced in, and future earnings growth could be more pedestrian.
A survey by Bank of America Merrill Lynch reported many large fund managers became more lukewarm toward banks in the December quarter, with close to 60% saying they were somewhat or very "underweight" bank stocks. This suggests professional money managers have reduced exposure, which is a useful signal for everyday investors to consider when weighing bank investments.
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