Have the big four banks peaked?

Margin pressure from low rates could pull soaring performance back to earth

Have the big four banks peaked?

Australia’s big banks are enjoying the fruits of asset sales and government support related to COVID-19, but they will soon face margin pressures as cheap funding ends and low interest rates continue, analysts say.

The big four accumulated surplus capital last year and have started to return some of it to shareholders through higher dividends and share buybacks. The banks also benefited from the Reserve Bank of Australia’s term funding facility, which provided $200 billion in cheap funding, and the sale of many non-core businesses. All of these factors greatly boosted the major banks’ capital ratios and profits, according to a report by S&P Global.

However, their earnings will likely show the effects of weakening net interest margins this year, with the TFF a thing of the past and interest rates likely to remain low as the pandemic continues.

“The low lending rates have been offset by a flood of cheap customer deposits and access to the TFF, but that tailwind is running its course,” Nathan Zaia, equity analyst at Morningstar, told S&P Global. “All banks pointed towards margins being under pressure in the next 12 months, especially if demand for fixed-rate loans remains so high.”

When it reported its full-year results last week, Commonwealth Bank said it expects “a number of headwinds to impact group NIM in the next financial year.” CBA cited the continued low-rate environment, increased competition, customers switching to fixed-rate mortgages and higher deposit rates as factors that would impact its net interest margin. The bank’s NIM fell to 2.03% in the fiscal year ending June 30, from 2.07% the previous year, according to S&P Global.

Westpac, which follows a different fiscal calendar, said in its third-quarter trading update Tuesday that its NIM in the second fiscal half could be lower than in the first. Westpac earlier reported that NIM in the first half, which ended March 31, was 2.06%, down from 2.21% the prior year. Westpac’s profits still rose thanks to the TFF support despite the fall in margins, S&P Global reported.

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The banks still boast strong balance sheets. CBA plans to buy back up to $6 billion in shares. ANZ and NAB have offered to buy back $1.5 billion and $2.5 billion in shares, respectively. Westpac said it would consider a return of capital, with an update at its full-year results, S&P Global reported.

Despite the drag on margins, the major banks are in robust financial health. The banks predict a strong economic rebound once the current lockdowns end, and pressures on the housing market have also eased, with fewer home loan borrowers seeking deferrals.

“It looks like all of the banks are quite well-capitalised and there hasn’t been any meaningful uptick in loan losses so far,” Omkar Joshi, principal and portfolio manager at Opal Capital, told S&P Global. “Obviously, the current lockdowns do pose an element of uncertainty, but for now the banks appear to be in a good position.”