Analysts warn on bank earnings growth

Bank earnings need to grow by an ‘improbable’ 30 per cent to restore the historical earnings-to-share price relationship, Macquarie analysts say.

Australia's four big banks, CBA, Westpac, NAB and ANZ have all seen share price growth in excess of 24 per cent in the past year but the earnings outlook is weak, according to Macquarie analysts. Picture: NCA Newswire

There is limited scope for banks to grow into their elevated multiples in the next few years, with ultra-low impairment charges hindering an earnings recovery in the medium term.

That’s the view of Macquarie analysts who warn the market may reassess the lack of positive earnings drivers for Australia’s big four lenders as the odds of a soft landing for the broader economy diminish.

Despite delivering around 30-45 per cent total shareholder return over the past year, banks’ earnings have declined as multiples have expanded by around 25-35 per cent, the analysts said in a note to clients

“While multiple expansions often precede the earnings growth phase, this is an improbable outcome, in our view. Periods where the earnings subsequently lifted to support rallying share prices were generally characterised by normalising credit losses following an impairment cycle.

“On the contrary, banks are now experiencing one of the lowest bad debts on record, and impairment charges cannot underpin an earnings recovery over the next few years,” they wrote in the note.

The majors booked $1.21bn in impairment charges in the first half of the year, 13 per cent lower than over the prior 12 months, according to consultancy KPMG. Over the first half, the average provisions as a percentage of gross loans and advances remained steady at 0.68 per cent.

Bank share prices, meanwhile, have continued to push higher, with National Australia Bank climbing 38 per cent in the past 12 months, Westpac rising 31 per cent, CBA lifting 28 per cent and ANZ up 24 per cent.

Bumper capital management programs, including buybacks and special dividends, have helped boost share prices as lenders eye lacklustre growth alongside swollen balance sheets.

But the Macquarie analysts warned of a murky outlook ahead as earnings look likely to come under pressure.

“Looking forward, we do not see a clear path for underlying profitability to improve meaningfully from a top-down and divisional bottom-up perspective,” Macquarie analysts warned clients.

“We note that banks’ current returns are broadly in the middle of their 10-year average ranges. As a result, we see limited scope for banks to grow into their elevated multiples.”

While CBA and NAB have improved their underlying returns over the last three years, ANZ and Westpac have seen their profitability decline. Differences in performance appear to be driven by variance in the business mix and some franchise-specific issues, the analysts noted.

“We see banks as expensive at current levels, trading at around a 15-30 per cent price/earnings relative premium versus five-year historical averages,” the analysts said.

For the historical earnings-to-share price relationship to be restored, bank earnings need to grow by around 30 per cent, a scenario the Macquarie analysts deemed improbable based on the current pre-provision growth outlook.

“With odds of achieving a soft landing arguably diminishing and an absence of positive earnings drivers, we see a risk of the market reassessing abnormally low impairment charge expectations and elevated bank multiples,” they warned.

Macquarie is underweight the sector over the medium term.